California’s AB5 law made it significantly harder to classify workers as independent contractors. It went into effect in 2020 and applies the ABC test to most working relationships. The default assumption under AB5 is that every worker is an employee unless your business can prove otherwise by satisfying all three parts of the test.

The ABC test has three prongs and you must meet all of them for a worker to qualify as an independent contractor. Prong A requires that the worker is free from your control and direction when performing the work, both in practice and under the terms of the contract. Prong B says the worker must perform work that is outside the usual course of your business. Prong C requires the worker to be customarily engaged in an independently established trade, occupation, or business of the same nature as the work they’re doing for you. Fail any single prong and the worker is an employee under California law.

Prong B is the one that trips up most business owners. If you run a marketing agency and hire a freelance graphic designer to do design work for clients, that designer is performing work within the usual course of your business. Under AB5, that person is likely an employee. If that same agency hires an electrician to fix a light in the office, that’s outside the usual course of business and passes prong B.

There are exemptions. AB2257 expanded on the original law and carved out specific professions and business-to-business relationships. Licensed professionals like lawyers, architects, accountants, and real estate agents have their own exemption criteria. The business-to-business exemption applies when a contractor operates as a separate business entity, has their own clients, sets their own rates, and doesn’t rely on you as their sole source of income. Each exemption has its own set of conditions that must all be met.

Misclassification carries real consequences. California’s EDD can audit your business and reclassify workers retroactively. That means back payroll taxes, penalties, interest, and potentially paying for benefits those workers should have received. The Franchise Tax Board, the IRS, and even the workers themselves can come after you. Penalties stack up fast and can be devastating for a small business.

From a practical standpoint, here is what you should do. Review every contractor relationship you currently have and run it through the ABC test honestly. If someone doesn’t clearly pass all three prongs and doesn’t fall under a specific exemption, you probably need to reclassify them as an employee. Talk to an employment attorney if you’re unsure about borderline cases because the cost of a consultation is nothing compared to the cost of an audit.

For workers who legitimately qualify as independent contractors, keep your documentation tight. Have written contracts that reflect the independent nature of the relationship. Make sure they invoice you, control their own schedule, use their own tools, and maintain their own business presence. When it comes time for 1099 preparation at year end, your records should clearly support the classification.

Keep your books organized so that employee wages and contractor payments are tracked separately and accurately. If you ever face an audit, clean financial records make it much easier to demonstrate that you classified and paid workers correctly. A bookkeeper in Long Beach who understands California’s requirements can help you maintain that separation and flag potential issues before they become expensive problems.

AB5 isn’t going away. The best approach is to understand the rules, classify workers honestly, and keep records that back up your decisions. Getting this right from the start saves you from the headaches of fixing it later.