Independent Contractor vs. Employee: What California Employers Need to Understand about the ABC Test
Employers may be tempted to classify certain workers as independent contractors in order to avoid obligations associated with employees, such as payroll taxes, workers’ compensation coverage, paid leave and other legally required benefits. But California law presumes that all workers are employees, unless the employer can establish that a worker qualifies as an independent contractor. For most workers, classification is governed by the “ABC Test,” which requires that the employer satisfy all three of its prongs. A carefully drafted independent contractor agreement can also provide important evidence supporting the classification if the worker’s status is later challenged.
The ABC Test
California intentionally makes it difficult for employers to use contractors. Unlike employees, contractors are not given basic safeguards such as minimum wage protections and workplace benefits. Further, an independent contractor relationship deprives state and federal governments of automatic payroll tax withholdings. To prove that someone is truly a contractor, California imposes the strict ABC Test on most employers, which requires:
A. That the worker is free from the control and direction of the business in connection with the performance of the work;
B. That the worker performs work that is outside the usual course of the hiring entity’s business; and
C. That the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.
Proving prong B is particularly challenging. Under this prong, the worker must be performing services outside the main services that the company provides. Therefore, if you are hiring someone to perform work that is core to your business, that person will never qualify as an independent contractor. For instance, a law firm must classify a paralegal as an employee, but it may be able to classify a pest control specialist as a contractor.
Independent Contractor Agreements
Employers should have an expertly drafted independent contractor agreement in place for every worker classified as an independent contractor. An independent contractor agreement itself does not make someone a contractor, but it can help you justify your position if you are audited by the California Labor Commissioner’s Office or sued in court by someone claiming they were misclassified.
The language in your independent contractor agreement should be consistent with and speak to the practical requirements of the ABC Test.
Additionally, certain verbiage cannot be included in the agreement without jeopardizing the individual’s status as a contractor. In particular, companies need to be careful with intellectual property ownership clauses.
In employment agreements, companies typically require that for work product created by the worker in their role with the company, the company retains ownership of the copyright, trademark, or other intellectual property. However, by inserting a standard intellectual property clause into a contractor agreement, you may be unknowingly converting a contractor to an employee.
It is possible to protect your intellectual property when working with independent contractors, but drafting such an agreement requires expertise in California employment law to avoid risking the individual’s status as a contractor.
Reducing Income Tax Liability
The law imposes several penalties on employers for misclassifying employees as contractors. One of the most expensive risks is income tax liability. Employers have withholding and payroll tax obligations for employees. If an employer fails to meet these obligations due to misclassification of workers as contractors, and the workers do not pay their income taxes, the employer may be responsible for back taxes, interest and penalties. A practical safeguard to help mitigate this risk is to stipulate in your independent contractor agreement that you have the right to request proof that workers are paying their quarterly taxes.
Exceptions to the ABC Test
You may not have to deal with the ABC Test at all. After California first adopted the new test in 2018, the lobbying arms of many industries successfully petitioned state government for exemptions. As a result, California law carves out a patchwork of explicit exemptions, which range from competition judgments to songwriters.
If you qualify for an exemption, don’t celebrate just yet. This simply means you have to meet the previous standard, the Borello Test, which many businesses find more challenging than the ABC Test because of its ambiguity. The Borello Test weighs 11 factors, but it has never been clear how many of these points must be met to prove whether a worker is a contractor. The ABC Test was passed into law to provide greater certainty – but the certainty it provides is that it’s almost impossible to classify someone as an independent contractor in California.
The Takeaway
In California, employers who are considering classifying a worker as an independent contractor should carefully weigh the risks. As California law presumes workers to be employees, employers are already swimming upstream when they classify a worker as a contractor. Depending on the circumstances, the employer will need to satisfy either the ABC Test or the Borello Test in addition to supporting their classification decision with an expertly drafted independent contractor agreement.
Jeffrey S. Sloan is the Managing Shareholder of Workplace Legal, APLC, an employment law firm with offices in San Francisco, Oakland, and New York. For over 30 years, Jeffrey has represented businesses of all sizes, as well as high-level executives and professionals, in complex labor, employment, and HR matters.
