Independent Contractor

What Is an Independent Contractor?

An independent contractor is a self-employed individual or business that provides services to another entity without being classified as an employee. Unlike employees, independent contractors operate their own businesses, control how they perform their work, and typically serve multiple clients.

In California, the distinction between employees and independent contractors carries enormous legal significance. Since the passage of Assembly Bill 5 (AB5) in 2019, California applies the strict ABC test to determine worker status, making it one of the most challenging states in the nation for businesses seeking to use independent contractors.

Why Classification Matters

The employee vs. independent contractor distinction affects nearly every aspect of the working relationship:

For Businesses

Obligation	Employee	Independent Contractor
Minimum wage	Required	Not applicable
Overtime pay	Required (non-exempt)	Not applicable
Meal breaks	Required	Not applicable
Rest breaks	Required	Not applicable
Payroll taxes	Employer pays share	Contractor pays own
Workers' compensation	Required	Not required
Unemployment insurance	Required	Not required
Benefits (health, retirement)	Often provided	Not provided
Employment discrimination laws	Apply	Limited application
Termination restrictions	Apply	Generally none

For Workers

Factor	Employee	Independent Contractor
Tax withholding	Automatic	Self-managed
Job security	Some legal protections	Terminable at will
Benefits eligibility	Often eligible	Self-funded
Workers' comp coverage	Covered	Must obtain own
Unemployment benefits	Eligible	Generally ineligible
Expense reimbursement	Required under CA law	Included in contract rate
Schedule control	Employer-directed	Self-directed

California's ABC Test

California uses the ABC test under Labor Code Section 2750.3 (codified by AB5) to determine worker classification. Under this test, a worker is presumed to be an employee unless the hiring entity demonstrates ALL three conditions:

A - Autonomy

The worker is free from the control and direction of the hiring entity in performing the work, both under the contract and in fact.

B - Business

The worker performs work that is outside the usual course of the hiring entity's business.

C - Customary

The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

All three prongs must be satisfied for independent contractor status. Failure on any single prong means the worker is an employee.

Applying the ABC Test

Prong A: Freedom from Control

This examines whether the worker controls HOW they perform their work:

Factor	Points Toward Contractor	Points Toward Employee
Work schedule	Sets own hours	Company-assigned schedule
Work location	Chooses where to work	Must work at company site
Methods	Determines how to do the job	Follows company procedures
Equipment	Uses own tools/equipment	Uses company-provided equipment
Training	Not required to attend	Required company training
Supervision	Works independently	Regularly supervised

Example - Contractor: A freelance web developer who sets their own hours, works from their home office, uses their own computer, and decides how to code the project.

Example - Employee: A "freelance" worker required to work 9-5 at the company office, attend meetings, follow company coding standards, and report to a supervisor daily.

Prong B: Outside Usual Course of Business

This is often the most difficult prong to satisfy. The work must be outside the hiring company's regular business:

Hiring Company	Outside Business (Contractor OK)	Inside Business (Employee)
Restaurant	Plumber fixing pipes	Cook preparing food
Law firm	IT consultant setting up servers	Lawyer handling cases
Trucking company	Accountant doing taxes	Driver delivering goods
Software company	Electrician installing lights	Developer writing code
Retail store	Window washer cleaning exterior	Sales associate serving customers

Key question: Would this work be performed by an employee in the normal course of the business?

Example - Fails Prong B: A trucking company hiring "independent" drivers to deliver cargo. Delivery IS the trucking company's business.

Example - Passes Prong B: A trucking company hiring a marketing consultant for a branding project. Marketing is outside the trucking business.

Prong C: Independently Established Business

The worker must have an existing business, not one created solely for this engagement:

Factor	Points Toward Contractor	Points Toward Employee
Business entity	Has LLC, corporation, or DBA	No business structure
Other clients	Works for multiple companies	Works only for this company
Marketing	Advertises services	No marketing efforts
Business expenses	Maintains own insurance, licenses	No business overhead
Industry reputation	Known in the field	New to the work
Business investments	Owns significant equipment/tools	No capital investment

Example - Contractor: A licensed electrician with an established business, multiple clients, company truck, liability insurance, and advertising.

Example - Employee: A worker who was an employee, became a "contractor" doing the same work for the same company only, with no other clients or business presence.

Exemptions from the ABC Test

AB5 includes numerous exemptions where the older, more flexible "Borello" test applies instead:

Professional Services Exemptions

Profession	Additional Requirements
Licensed lawyers	State Bar license
Licensed architects	State license
Licensed engineers	State license
Licensed accountants	CPA license
Licensed insurance agents	State license
Securities broker-dealers	FINRA registration
Investment advisers	SEC/state registration
Direct sales	Specific statutory exemption
Real estate agents	Licensed, specific conditions
Repossession agents	Licensed

Business-to-Business Exemption

The B2B exemption applies when ALL of the following are met:

1. Written contract specifying payment
2. Contractor has required licenses
3. Contractor maintains business location separate from hiring entity
4. Contractor can negotiate rate
5. Contractor sets own hours (outside of reasonable deadlines)
6. Contractor works for other clients
7. Contractor can hire employees
8. Contractor provides own tools
9. Contractor can profit or lose money
10. Services outside usual course of hiring entity's business
11. Contractor can substitute workers
12. Not performing services on ongoing basis

Other Exemptions

• Construction subcontractors (with proper licensing)
• Referral agencies (with specific conditions)
• Motor club services
• Newspaper distributors and carriers
• International exchange visitors

Consequences of Misclassification

Misclassifying an employee as an independent contractor exposes businesses to significant liability:

Back Wages and Benefits

Category	Potential Liability
Overtime	3 years of unpaid overtime + liquidated damages
Meal break premiums	1 hour pay per missed break
Rest break premiums	1 hour pay per missed break
Expense reimbursement	All unreimbursed business expenses
Minimum wage shortfalls	Difference from minimum wage

Tax Penalties

Tax Type	Liability
Unpaid employment taxes	Back taxes + interest
IRS penalties	Varies by willfulness
EDD penalties	Back taxes + penalties
Worker's comp premiums	Back premiums + penalties

Additional Penalties

Penalty Type	Amount
Wage statement penalties	$50-$100 per statement
Waiting time penalties	Up to 30 days' wages
PAGA penalties	$100-$200 per pay period
Willful misclassification (Labor Code 226.8)	$5,000-$25,000 per violation
Pattern of willful misclassification	$10,000-$25,000 per violation + posting requirement

Proper Use of Independent Contractors

Legitimate Independent Contractor Relationships

Independent contractor status is appropriate when:

1. The worker has a genuine independent business
2. The work is truly outside your core business
3. The worker controls how, when, and where they work
4. The engagement has defined scope and duration
5. The worker has multiple clients
6. No ongoing, indefinite engagement

Industries Where Contractors May Be Appropriate

Industry	Potential Contractor Uses
Any business	Attorneys, accountants, tax professionals
Any business	IT consultants (discrete projects)
Any business	Marketing/branding consultants
Construction	Licensed specialty subcontractors
Events	One-time specialized performers
Real estate	Licensed agents (with proper structure)

Best Practices for Using Contractors

1. Written agreement: Clearly define scope, deliverables, payment terms
2. No control over methods: Specify results, not how to achieve them
3. Project-based: Define start/end dates or specific deliverables
4. Separate from employees: Don't have contractors do the same work as employees
5. Verify independent business: Check for other clients, business presence
6. No exclusivity: Don't require contractor to work only for you
7. No training: Contractors should already have the required expertise
8. Contractor provides tools: Don't provide equipment or supplies

What Not to Do

Red Flags That Signal Misclassification

Don't	Why It's Problematic
Convert employees to contractors	Same work = same classification
Require set schedule	Removes autonomy
Require on-site work	Controls work location
Provide equipment/tools	Indicates employee relationship
Give detailed instructions	Controls method of work
Prohibit other clients	Eliminates independence
Indefinite engagement	Suggests ongoing employment
Integrate into team	Suggests employee status

Common Misclassification Scenarios

Scenario 1: Company lays off workers, then rehires them as "contractors" doing the same work.

Result: Clear misclassification. Same work, same relationship = employees.

Scenario 2: Delivery company classifies all drivers as contractors.

Result: Fails Prong B. Delivery is the company's core business.

Scenario 3: Tech company uses "contractors" who work full-time on-site, use company equipment, attend meetings, and have only this client.

Result: Fails all three prongs. These are employees.

Compliance Checklist

Before engaging an independent contractor, verify:

• Worker has established independent business
• Worker has other clients (not exclusively working for you)
• Work is outside your company's usual course of business
• Worker controls methods, schedule, and location
• Written contract defines scope and deliverables
• No exemption applies that would use Borello test instead
• Worker provides own tools and equipment
• Engagement has defined scope (not indefinite)
• Worker is not performing same work as employees
• Worker can substitute other workers
• Worker can profit or lose money on the engagement