Table of Contents
- Independent Contractor or Employee
- The Test for Independent Contractor or Employee
- Borello: Multi-Factor “Manner and Means” Test
- The “ABC” Test
- If the work relationship meets the requirements of an exemption, the Borello Test applies instead of the ABC Test.
- Exceptions to the ABC Test
- Business–to-Business Exemption.
- Professional Services Exemption.
- Referral Agency Exemption.
- Recording Industry Exception.
- Single-Engagement Event Exception.
- Specific Occupation Exemptions.
- App-Based Drivers.
- If There are significant consequences for misclassifying a worker as an independent contractor
- Wage-and-Hour & Workplace Legal Protections
- Insurance Benefits & Taxes
- Legal Liability for Misclassifying a Worker
All workers are either classified as an employee or an independent contractor. The hiring entity and worker do not decide the “employee or contractor” classification question; the law makes the decision. All workers are presumed to be employees (and are covered by laws protecting employees) unless they and the company can prove otherwise.
Independent Contractor or Employee
- An agreement between the hiring entity and worker, the labeling of the worker (i.e., “employee” versus “independent contractor,” “freelancer,” or “consultant”), nor the tax forms used — i.e., 1099 for contractors versus W-2 for employees — is outcome determinative. The working relationship must satisfy one of several legal tests to classify the worker as a contractor.
- Classifying a worker as an independent contractor versus an employee is legally significant because almost all worker legal protections – e.g., minimum wage, overtime, anti-discrimination, insurances, and taxes – depend on if the worker is a contractor or employee in the eyes of the law.
- Because of tax benefits and the flexibility of working for themselves, many workers prefer contractor status. Businesses often prefer contractors for the flexibility in structuring payment, and to avoid many costly legal obligations for employees. Since worker and business incentives align on the contractor preference, many workers end up “misclassified.”
The Test for Independent Contractor or Employee
- The applicable independent contractor or employee test depends on legal right at issue – e.g., unpaid wages, breaks, harassment, discrimination, unemployment insurance benefits, workers’ compensation insurance benefits, taxes, etc. – and the nature of the relationship between the entity and worker.
- Before the “ABC test” was introduced in 2018, the multi-factor “manner and means” test that the California Supreme Court set forth in in S. G. Borello & Sons, Inc. v. Dep’t of Indus. Relations, 48 Cal.3d 341 (1989) (“Borello”) was used across the board. Now, the Borello multi-factor test is used as a fallback when the ABC test does not apply because of a statutory exemption.
- In 2018, the California Supreme Court introduced the ABC test in the Dynamex case; in 2019, the Legislature codified the ABC test via Assembly Bill 5 (“AB 5”); and, in September 2020, Assembly Bill 2257 (“AB 2257”) rewrote much of AB 5. Unless there is a statutory exemption, the ABC test is used for legal rights arising under California wage and hour, workers’ compensation insurance, and unemployment insurance law.
- Other classification tests are used for: discrimination and harassment protections under the California Fair Employment And Housing Act (Government Code section 12940(j)(5)); employment protections under federal statutes (Nationwide Mut. Ins. Co. v. Darden, 503 U.S. 318, 324 (1992)); and federal tax purposes (Internal Revenue Service, Publication 15-A: Employer’s Supplemental Tax Guide (2017)).
Borello: Multi-Factor “Manner and Means” Test
- From 1989 to 2018, the classification test for contractor or employee that California courts, the California Labor Commissioner, and the California Employment Development Department used was the multi-factor test established by the California Supreme Court in S. G. Borello & Sons, Inc. v. Dep’t of Indus. Relations, 48 Cal.3d 341 (1989) (“Borello”).
- The Borello test applied until 2018, when Dynamex introduced the ABC test for certain purposes. The Borello test remains in place as the applicable test when a statutory exception to the ABC test applies. More simply, businesses that meet a statutory exception to the ABC test must still satisfy the Borello test to avoid the consequences of misclassifying an employee as a contractor. Labor Code section 2775(b)(3).
- Businesses prefer the Borello test because the many factually-intensive factors can complicate worker claims and class certification efforts, and to avoid the “B” element of the ABC test
- The California Labor Commissioner describes the Borello test as: “…[relying] upon multiple factors to make [the contractor or employee] determination, including whether the potential employer has all necessary control over the manner and means of accomplishing the result desired, although such control need not be direct, actually exercised or detailed. This factor, which is not dispositive, must be considered along with other factors.
- Whether the worker performing services holds themselves out as being engaged in an occupation or business distinct from that of the employer [yes leans towards contractor];
- Whether the work is a regular or integral part of the employer’s business [no leans towards contractor];
- Whether the employer or the worker supplies the instrumentalities, tools, and the place for the worker doing the work [yes leans towards contractor];
- Whether the worker has invested in the business, such as in the equipment or materials required by their task [yes leans towards contractor];
- Whether the service provided requires a special skill [yes leans towards contractor];
- The kind of occupation, and whether the work is usually done under the direction of the employer or by a specialist without supervision [without direction or supervision leans towards contractor];
- The worker’s opportunity for profit or loss depending on their managerial skill [more opportunity leans towards contractor];
- The length of time for which the services are to be performed [shorter time leans towards contractor];
- The degree of permanence of the working relationship [less permanence leans towards contractor];
- The method of payment, whether by time or by the job [by the job and not by time leans towards contractor];
- Whether the worker hires their own employees [yes leans towards contractor];
- Whether the employer has a right to fire at will or whether a termination gives rise to an action for breach of contract [no to right to fire at will leans towards contractor]; and
- Whether or not the worker and the potential employer believe they are creating an employer-employee relationship (this may be relevant, but the legal determination of employment status is not based on whether the parties believe they have an employer-employee relationship) [no leans towards contractor].”
The “ABC” Test
- In Dynamex Operations West, Inc. v. Superior Court (“Dynamex”), the California Supreme Court revisited the proper classification test for purposes of claims under the California Wage Orders, which cover overtime and breaks (but not expense reimbursement). The Dynamex Court ruled that the multi-factor test established in Borello was not the proper test, and that the ABC test applied in these circumstances. In 2019, AB 5 codified the Dynamex ABC test in California Labor Code section 2750.3.
- The ABC test applies for purposes of the Unemployment Insurance Code and all provisions of the Labor Code for purposes of workers’ compensation insurance.
- Simply put, to legally classify a worker as an independent contractor and not an employee, a company must prove that the worker is free from the company’s control, performs work outside the company’s primary business, and is regularly engaged in the trade the worker is hired for, independent of work for the company.
- Under the ABC test, a worker is presumed to be an employee unless the business proves each of the three elements:
- Autonomous Worker. The worker is free from the control and direction of the company in performing work, both practically and in the contractual agreement between the parties; and
- Business Difference. The worker performs work that is outside the usual course of the company’s business; and
- Customer of Worker. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the company.
If the work relationship meets the requirements of an exemption, the Borello Test applies instead of the ABC Test.
Exceptions to the ABC Test
- The ABC test has exemptions built in. If the work relationship meets the requirements for an exemption to the ABC test, instead the the Borello multi-factor test applies.
- Businesses that meet a statutory exception to the ABC test must still satisfy the Borello test to avoid the consequences of misclassifying an employee as a contractor. Labor Code sections 2775-2787. Companies prefer the Borello test because the many factually-intensive factors can complicate worker claims and class certification efforts, and to avoid the “B” element of the ABC test.
A business entity, including an individual operating as a sole proprietorship, other than a licensed contractor, may be classified as a contractor (subject to the Borello test) if all of the following criteria are satisfied (Labor Code § 2776):
- The provider is free from the control and direction of the contracting business;
- Services are provided directly to the contracting business and not that business’s customers unless employees of the provider are performing the services for the customer and the provider regularly engages in this business;
- There is a written contract that includes certain required terms (payment amount or method and due date);
- The provider has a business license or tax registration if required in the location where the services are performed;
- The provider maintains a business location separate from the hiring entity (which may include the contractor’s home);
- The provider is customarily engaged in an independently established business of the same nature as the services;
- The provider is free to contract with others for the same or like services;
- The provider advertises and holds itself out to the public as available for like services;
- The provider uses its own tools, vehicles, and equipment, not including any proprietary materials that are necessary to perform the services;
- The provider negotiates its own rates; and
- The provider can set its own hours and work location consistent with the nature of the work.
Professional Services Exemption.
A worker may be classified as a contractor (subject to the Borello test) if they meet all of these criteria (Labor Code § 2778):
- Maintains a business location, which may be their residence, separate from the hiring entity, but with certain exceptions (stated below) the person may choose to perform services at the hiring entity’s location;
- Has a business license or tax registration if required in the location where the services are performed and a professional license if required by the profession;
- Has the ability to set or negotiate their own rates;
- Outside of project completion dates and reasonable business hours, can set their own hours;
- Is customarily engaged in the same type of work for another hiring or holds themselves out to potential customers for that type of work;
- Customarily and regularly exercises discretion and independent judgment in the performance of the services; and
- The work is for “professional services” which means any of the following:
- Marketing, provided that the work is original and creative.
- Administrator of human resources, provided that the work is predominantly intellectual and varied.
- Travel agent, provided they either are regulated or are exempt from registration.
- Graphic design.
- Grant writer.
- Fine artist, defined as someone who creates work of art appreciated for the imaginative, aesthetic, or intellectual content, including paintings, sculptures, etc.
- Enrolled agent licensed by the U.S. Treasury Department.
- Payment processing agent through an independent organization.
- Still photographer, photojournalist, videographer, or photo editor who does not work in motion pictures (including theatrical or commercial productions, broadcast news, television, and music videos) who works under a written contract specifying the rate of pay and deadline for payment, is not replacing an employee who performed the same work at the same volume for the hiring entity, does not primarily perform the work at the hiring entity’s location, and is not restricted from working for other entities. [The previous limit of 35 submissions per year has been removed for this exception.]
- Freelance writer, translator, editor, copy editor, illustrator, newspaper cartoonist, content contributor, advisor, producer, narrator, or cartographer for a journal, book, periodical, evaluation, other publication or educational, academic or instructional work in any format or media who works under a written contract specifying the rate of pay, deadline for payment, and intellectual property rights, is not replacing an employee who performed the same work at the same volume for the hiring entity, does not primarily perform the work at the hiring entity’s location, and is not restricted from working for other entities. [Again, the 35-submission limit has been removed for this exception.]
- Licensed esthetician, electrologist, manicurist, barber, or cosmetologist.
- Specialized performers hired by a performing arts company or organization to teach a “master class” for no more than one week.
- Licensed real estate appraisers, licensed real estate agents (with caveats), home inspectors, and repossession agents.
Referral Agency Exemption.
A service provider, including an individual operating as a sole proprietorship, that provides services to clients through a referral agency may be classified as a contractor (subject to the Borello test) if the provider satisfies all of the following criteria (Labor Code § 2777):
- A “referral agency” is a business that provides clients with service providers except those in high hazard industries or the janitorial, delivery, courier, transportation, trucking, agricultural labor, retail, logging, in-home care, or construction industries. Examples of referral services that meet this exemption are tutors, youth sports coaches, interpreting services, consulting, and animal services.
- A “client” is either an individual contracting for services, or a business that uses a referral agency to contract for services that are otherwise not provided on a regular basis at the client’s business location, or to contract for services that are outside of the client’s usual course of business.
- The provider is free from the control and direction of the referral agency both as a matter of contract and in fact;
- If the work is performed in a jurisdiction that requires a business license or business tax registration, or if the work requires a professional license, the provider has satisfied the requirements and certifies compliance to the referral agency;
- Services are provided in the provider’s name and not the name of the referral agency;
- The provider provides their own tools and supplies;
- The provider is customarily engaged or was previously engaged in an independently established business or trade of the same nature;
- The referral agency does not restrict the provider from maintaining a clientele and the provider is free to seek work elsewhere, including through a competing referral agency;
- The provider sets their own hours and terms of work or negotiates these with the client;
- Without deduction by the referral agency, the provider sets their own rates, or negotiates the rates through the agency or directly with the client, or is free to accept or reject rates set by the client; and
- The provider is free to accept or reject clients and contracts without penalty unless a client or contract has been accepted.
Recording Industry Exception.
Workers in these categories may be classified as contractors (subject to the Borello test) if they satisfy certain criteria (Labor Code § 2780):
- Recording artists, songwriters, lyricists, composers and proofers, artists’ managers;
- Record producers and directors;
- Engineers and mixers;
- Musicians engaged in sound recordings;
- Photographers working on recording photo shoots, album covers, and for other publicity purposes;
- Independent radio promoters; and
- Others engaged in the creation, production, marketing, or independent music publicist services mainly related to the creation, marketing, promotion or distribution of sound recordings or musical compositions except those on film and television unit production crews working on live or recorded performances for audiovisual works.
Single-Engagement Event Exception.
The relationship between two individuals or business entities created for purposes of providing services at the location of a single-engagement event, defined as a stand-alone, non-recurring event in a single location, or a series of events in the same location no more than once a week, may be classified as contractors (if they satisfy the Borello test) if the following requirements are satisfied (Labor Code § 2779):
- Neither individual is subject to the control or direction of the other;
- Each individual has the ability to negotiate their rate of pay;
- The written contract specifies the total payment for services and the amount paid to each;
- Each individual maintains their own business location, which may include their home;
- Each individual provides their own tools, vehicles, and equipment;
- If the work is performed in a jurisdiction that requires a business license or business tax registration, each individual has complied;
- Each individual is customarily engaged in the same or similar type of work or holds themselves out to other potential customers; and
- Each individual can contract with other businesses and maintain their own clientele without restrictions.
Specific Occupation Exemptions.
Some of the other occupations that may be classified as contractors (subject to passing the Borello test) and satisfy a variety of other requirements include:
- A licensed physician and surgeon, dentist, podiatrist, psychologist, or veterinarian performing professional or medical services provided to or by a health care entity. Labor Code § 2783.
- Licensed and practicing lawyer, architect, landscape architect, engineer, private investigator, or accountant. Labor Code § 2783.
- Licensed securities broker-dealer or investment adviser or their agents and representatives. Labor Code § 2783.
- A direct sales salesperson as described in Unemployment Insurance Code § 650, so long as the conditions for exclusion from employment under that section are met. Labor Code § 2783.
- Individuals who provide underwriting inspections, premium audits, risk management, or loss control work for insurance and financial service industries. Labor Code § 2783.
- Construction workers. Labor Code § 2781.
- Data aggregators. Labor Code § 2782.
- Landscape architects. Labor Code § 2783.
- Manufactured housing salesperson. Labor Code § 2783.
- Commercial fishers working on an American vessel. Labor Code § 2783.
- Newspaper distributors working under contract with a newspaper publisher and newspaper carriers under contract either with the publisher or distributor. Labor Code § 2783.
- Individuals engaged by an international exchange visitor program. Labor Code § 2783.
- Competition judges such as amateur umpires or referees. Labor Code § 2783.
- Individual performing services for a third party on behalf of a certified motor club. Labor Code § 2784.
The Proposition 22 ballot initiative passed during the 2020 election carved app-based drivers out of the ABC test and made them independent contractors with special benefits.
- App-based drivers are considered workers who either: provide delivery services on an on-demand basis through a business’s online-enabled application or platform; or use a personal vehicle to provide prearranged transportation services for compensation via a business’s online-enabled application or platform.
- Proposition 22 establishes a new set of minimum protections and benefits companies must provide to app-based drivers that do not apply to traditional independent contractors:
- Minimum Payment. Companies must pay the difference between a driver’s net earnings, excluding tips, and a net earnings floor of 120% of the local minimum wage applied to a driver’s “engaged time” (i.e., the time between accepting a service request and completing the request).
- Minimum Mileage Reimbursement. Companies must reimburse drivers at least 30 cents per mile during “engaged time” (to be adjusted for inflation after 2021).
- Mandatory Rest.Drivers are limited from working more than 12 hours during a 24-hour period, unless they have logged off for an uninterrupted 6 hours.
- Healthcare Stipend. Companies must provide healthcare subsidies equal to: (a) 82% the average California Covered premium for each month for drivers who average at least 25 hours per week of engaged time during a calendar quarter; and (b) 41% of the average California Covered premium for each month for drivers who average between 15 and 25 hours per week of engaged time during a calendar quarter.
- Accident Insurance. Companies must provide or make available occupational accident insurance to cover at least $1 million in medical expenses and lost income resulting from injuries suffered while a driver was online (i.e., when the driver is using the app and can receive service requests) but not engaged in personal activities. The insurance must provide disability payments of 66% of a driver’s average weekly earnings during the previous four weeks before the injuries suffered for up to 104 weeks.
- Policies, Trainings & Background Checks. Companies must develop anti-discrimination and sexual harassment policies, training programs for drivers related to driving, traffic, accident avoidance, and recognizing and reporting sexual assault and misconduct, maintain zero-tolerance policies for driving under the influence of drugs or alcohol, and mandate criminal background checks for drivers.
If There are significant consequences for misclassifying a worker as an independent contractor
Wage-and-Hour & Workplace Legal Protections
- Employees, but not contractors, are covered by most sections under the Labor Code. The significant wage and hour laws applying to employees that come with the steepest penalties include employees’ rights to:
- Minimum wage paid for all hours worked applies to employees only. Labor Code § 1182.12.
- Overtime pay if the work is more than a certain number of daily or weekly hours Labor Code § 510.
- Meal and rest breaks during the workday. Labor Code §§ 512.
- Reimbursement of reasonable expenses incurred in the course of employment. Labor Code § 2802.
- Most meaningful California workplace legal rights extend to employees, but not contractors.
- Employees are entitled leaves of absence when they or family members have a serious health condition. Government Code § 12945.2.
- Employers must engage disabled employees in the interactive process and provide reasonable accommodations. Government Code § 12940.
- Employees are protected from discrimination, retaliation, and wrongful termination based on protected categories. Government Code § 12940. (California law does protect contractors from workplace harassment.)
- California Division of Occupational Safety and Health workplace safety regulations covers employees. California Code of Regulations, Title 8, §§ 330–90.
Insurance Benefits & Taxes
- Employees are entitled to certain insurance benefits, while contractors are not:
- Workers’ compensation insurance is required for employees who suffer injuries/illnesses in the course of employment. Labor Code § 3700.
- State Disability Insurance provides short-term disability insurance and paid family leave wage replacement benefits to eligible employees who need time off of work.
- Unemployment Insurance provides unemployment benefits to employees who are unemployed through no fault.
- The federal tax obligations of workers and businesses differ depending on if the worker is classified as a contractor or employee. Businesses must withhold state and federal income and payroll taxes from an employee’s wages, but not from compensation paid to a contractor. Similarly, businesses are responsible for their own social security, Medicare, and unemployment taxes on wages paid to an employee, but not on compensation paid to a contractor. The distinction impacts:
- Self-employment taxes. 26 U.S.C. §§ 1401–1403.
- Social security and Medicare withholdings. 26 U.S.C. §§ 3101–3128.
- Unemployment insurance taxes. 26 U.S.C. §§ 3301–3311.
- Income tax withholdings. 26 U.S.C. §§ 3401–3406.
Legal Liability for Misclassifying a Worker
- Government Enforcement. The California Attorney General and certain city attorneys are empowered to pursue injunctions against businesses suspected of misclassifying workers. California district attorneys also have authority to bring enforcement actions.
- Worker Claims. A current or former worker can assert the following violations for independent contractor misclassification, which entitles them to back pay, premium payments, interest, attorneys’ fees and costs.
- Failure to provide a rest break. Labor Code §§ 512.
- Failure to provide a meal break. Labor Code §§ 512, 7, 1194.
- Failure to serve timely and accurate wage statements. Labor Code § 226(e).
- Failure to pay all wages owed upon separation. Labor Code §§ 201-203.
- Labor Code claims include prevailing party attorneys’ fees one-way in the employee’s favor only Labor Code § 218.5.
- Failure to pay minimum wages. Labor Code §§ 510, 1194, 2, 1197.
- Failure to pay overtime wages. Labor Code §§ 510, 1194.
- Failure to reimburse all necessary, business related expenses. Labor Code § 2802.
- Violation of CA’s Unfair Competition Law. Business and Professions Code § 17200.
- Private Attorney General Act. The California Private Attorney General Act (“PAGA”) provides that “aggrieved” employees with a private right of action against a California employer to collect penalties on behalf of the state’s Labor and Workforce Development Agency (LWDA) for violations of the Labor Code. PAGA requires that 75 percent of any penalties collected be paid to the LWDA, with the remaining 25 percent distributed to the aggrieved employees. PAGA lawsuits are more popular than class actions in California because (1) the absence of class certification requirements; (2) they are not arbitrable and (3) cannot be waived. For Labor Code provisions that do not specify the penalty amount PAGA provides default civil penalties at $100 for every employee for every pay period for the first violation, and $200 for each violation thereafter unless the Labor Code has a built-in civil penalty. Because separate penalties may be assessed for each Labor Code violation in the same pay period for the same underlying violation, the PAGA penalty exposure can grow exponentially.
- Immigration. This includes federal I-9 violations.
- Tax liability. Federal/state tax payroll tax liability (FICA, Medicare, social security).
- Criminal Liability. under federal tax laws, for example, intentional/fraudulent activity carries punishment of fines and possible imprisonment; the Labor Code criminalizes certain instances where employers willfully fail to pay earned wages.
- Unemployment Insurance. penalties for failure to pay the appropriate amount of money to the state unemployment insurance funds, which can be retroactive. The issue typically is whether the company’s records submitted to California Employment Development Department accurately report the number of employees because these are the reports the contribution is based upon.
- Workers Compensation Insurance. Penalties for violation of California workers’ compensation laws and liability for unpaid workers’ compensation premiums.
- Benefit Plans. Potential entitlement of misclassified worker for coverage under the company’s benefit plans, including retirement plans, health insurance, paid sick leave, etc.
- Other Laws. Violation of other state/federal employment laws: anti-discrimination, not providing leave to an eligible employee, and violations of reinstatement and leave rights for military personnel).
- Layoffs. Failure to count misclassified workers in determining state/federal WARN requirements in the event of layoffs/closings and failure to give WARN notices to affected misclassified employees.