Determining Worker Classification

California employers must navigate two distinct legal frameworks when classifying service providers as independent contractors rather than employees.

Federal Classification Requirements

As of March 11, 2024, the Department of Labor implemented a six-factor test for worker classification. Each factor carries equal weight:

• The worker's opportunity for profit or loss depending on managerial skill

• Investment levels by both the worker and the employer

• The degree of permanence in the working relationship

• The nature and extent of the employer's control over the worker

• Whether the work performed is integral to the employer's business

• The worker's use of specialized skills and initiative

California's AB 5 Requirements

Even if a working relationship satisfies the federal test, California's AB 5 law, effective January 1, 2020, requires compliance with the "ABC Test." All three criteria must be met simultaneously for independent contractor classification:

• The worker operates free from the hiring entity's control and direction in performing the work

• The work falls outside the hiring entity's usual course of business

• The worker maintains an independently established trade, occupation, or business in the same field

Numerous occupational exemptions exist for the ABC test, though the federal requirements still apply universally.

Consequences of Misclassification

Worker misclassification penalties are substantial: $5,000 to $15,000 per violation, plus unpaid taxes, penalties, and interest. Employers may also face liability for taxes that should have been withheld from employee wages. Even small payrolls can generate tens of thousands of dollars in total liability. Licensed contractors face additional reporting to the Contractors' State License Board.

Additional California Requirements

• California requires 7% withholding on payments exceeding $1,500 annually to nonresident independent contractors (those with non-California addresses), with remittance to the state.

• Corporate officers typically qualify as employees rather than independent contractors, regardless of whether their compensation is performance-based.

This information provides a general framework. For specific guidance on worker classification matters, consultation with an experienced CPA tax accountant is recommended.