Contractor or employee? California's ABC test

The three conditions

The California Supreme Court adopted the ABC test in Dynamex in 2018, and AB 5 codified it in the Labor Code in 2019, now at sections 2775 to 2787. Under the test, a worker is an employee unless the hiring entity shows that the worker is free from its control and direction in performing the work, the work is outside the usual course of its business, and the worker is customarily engaged in an independently established trade, occupation or business of the same nature.

The hiring entity carries the burden. The Labor Commissioner says the independent business must actually exist when the work is performed; that it could exist in the future is not enough. A company cannot decide a worker's status simply by calling the worker an independent contractor, and issuing a Form 1099 or having the worker sign a contractor agreement does not change status.

Where startups get caught

The second condition is often the hardest for an early-stage company. Work that is central to what the company sells is usually inside the usual course of its business. That puts product engineering, core design work or customer support for the company's own product at risk of being treated as employment, even when the person works remotely and sets their own hours.

Example: A SaaS startup engages a freelance developer for 40 hours a week to build its main product, under a contractor agreement and with no other clients. Writing the company's software is likely within the usual course of its business, and the developer does not appear to run an independent business. By contrast, an established agency that builds websites for many clients and redesigns the startup's marketing site is a more typical contractor arrangement.

Exemptions and next steps

The Labor Code exempts certain occupations and relationships from the ABC test. For these, status is decided under the multifactor Borello test, where no single factor controls. Examples include certain bona fide business-to-business contracting relationships, which must meet a list of statutory conditions, and certain professional services such as marketing, human resources administration and graphic design.

If someone is really an employee, the company takes on wage and hour, payroll tax, workers' compensation and wage notice duties. Review existing arrangements before a financing, because investors ask about classification in diligence. Where a contractor relationship is right, the agreement should still include confidentiality and an express assignment of intellectual property.

Your next steps

1. Test each contractor against all three ABC conditions, with evidence for each.
2. Check whether a statutory exemption applies and whether its conditions are actually met.
3. Reclassify where needed and keep IP assignments in every contractor agreement.