Most people have heard of the disputes in the gig work field (ride share services, food delivery services, etc) around employee versus contractor. Not everyone realizes those disputes, and the foundations they’re built on, extend to other roles that don’t mandate a phone charger to get through a shift. A miscalculation here can lead to fines, back taxes, and strained interoffice relationships with your team.
Why It Matters
You might see using contractors as a simple way to save on payroll taxes or benefits. Yet misclassification carries financial and legal risks. If authorities decide your “contractor” is actually an employee, you could owe back wages, penalties, and additional taxes. You also risk lawsuits over unpaid benefits or overtime.
What’s the Difference?
Control Over Work
If you set specific hours or monitor daily tasks, that person might be an employee.
Tools and Equipment
Providing the main tools or a workstation can signal employee status.
Payment Method
Hourly or salary-based pay often suggests employment. Contractors typically invoice for each project or milestone.
These points are useful signals, not the legal test, and in California the legal test is unusually strict.
The California ABC Test
Cal. Lab. Code § 2775, enacted by AB 5 and recast into its current form by AB 2257, codifies the Supreme Court’s decision in Dynamex Operations West, Inc. v. Superior Court (2018) 4 Cal.5th 903 and presumes that a worker is an employee. The hiring entity carries the burden of proving all three of the following, and failing any one of them makes the worker an employee:
- A. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract and in fact.
- B. The worker performs work that is outside the usual course of the hiring entity’s business.
- C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
Prong B is where technology companies fail. A software company that engages a developer as a contractor to build its product is asking that developer to perform work squarely inside the usual course of its business. A contractor who redesigns the office or handles the company’s payroll is not.
The Exemptions and the Borello Test
Cal. Lab. Code §§ 2776 through 2784 exempt a long list of occupations and relationships from the ABC test, including many professional services, certain business-to-business contracting relationships, referral agency relationships, single-engagement business-to-business arrangements, and specified licensed occupations such as lawyers, accountants, architects and engineers, each on its own conditions. An exemption does not make the worker a contractor. It moves the analysis to the older multifactor test from S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989) 48 Cal.3d 341, which weighs the right to control the manner of work alongside factors such as who supplies the tools, the method of payment, the skill required, the length of the relationship, and whether the work is part of the regular business of the principal. Each exemption has conditions. The business-to-business exemption in § 2776 lists twelve, among them a written contract, a separate business location, a business licence, the contractor’s freedom to set rates and hours, and that the contractor actually holds itself out to and contracts with other businesses.
What a Finding Costs
Beyond back wages, overtime, meal and rest premiums, unreimbursed business expenses under Cal. Lab. Code § 2802, and unpaid payroll taxes, Cal. Lab. Code § 226.8 makes wilful misclassification a separate violation carrying a civil penalty of $5,000 to $15,000 per violation, rising to $10,000 to $25,000 per violation where a pattern or practice is found. A person who violates the section and is a licensed contractor is also reported to the Contractors State License Board. Misclassification claims also travel well as representative actions under the Private Attorneys General Act, so the exposure is rarely limited to one worker, although a 2024 reform (AB 2288 and SB 92) now requires the named plaintiff to have personally experienced each violation pursued and gives courts more power to narrow unmanageable claims.
Common Concerns
“But my worker prefers to be a contractor!”
That preference doesn’t override legal standards. You still need to meet the classification rules.
“I can’t afford to put everyone on payroll.”
Short-term savings might lead to bigger losses if a regulator calls your setup into question.
“Will I face huge fines if I messed up?”
Early action can minimize penalties. If you suspect you’ve misclassified someone, consult an attorney. Adjusting arrangements now may help you avoid greater trouble later.
Practical Tips
Review Job Descriptions
Look at each position’s duties. Check if the worker acts under your direction or operates a separate business.
Use Written Agreements
For contractors, outline the scope of work, payment terms, and independence. If the job looks more like an employee’s role, shift to an employment agreement.
Stay Informed
Regulations change. Keep track of new laws to ensure you classify your staff correctly.
Misclassifying employees as contractors can create headaches you don’t need. By understanding the difference and acting with care, you protect your bottom line and your team’s trust. If you’re worried about a current setup, consider seeking legal advice. An informed choice now can spare you costly problems down the road.