Hiring employees

Employee or independent contractor?

An employee works for you and is under your control. An independent contractor runs their own business and sells services to you. The difference matters because you owe employees wages under wage-and-hour laws, workers' compensation coverage, and payroll taxes. You owe a true independent contractor only what the contract says.

In California, the starting point is the ABC test in Labor Code §2775. A person who is paid for labor or services is treated as an employee unless the hiring entity (the business that hires the worker) proves ALL three parts below. If even one part fails, the worker is an employee.

Part	What the hiring entity must prove
A	The worker is free from the hiring entity's control and direction in doing the work, both under the contract and in fact.
B	The work 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 kind as the work done.

Exam trap

The burden is on the business, not the worker. A signed 'independent contractor agreement' or paying someone on a Form 1099 does not make them a contractor. The test looks at the real relationship.

The construction subcontractor exception (Labor Code §2781)

Construction has its own rule. The ABC test does not apply to a contractor and an individual working under a construction subcontract if the contractor shows that ALL of these criteria are met:

The subcontract is in writing.
The subcontractor is licensed by CSLB, and the work is within the scope of that license.
If the subcontractor's city or county requires a business license or business tax registration, the subcontractor has it.
The subcontractor keeps a business location separate from the contractor's business or work location.
The subcontractor has authority to hire and fire people who help do the work.
The subcontractor takes financial responsibility for errors or omissions, shown by insurance, legal indemnity obligations, performance bonds, or warranties.
The subcontractor is customarily engaged in an independently established business of the same kind as the work.

If all seven criteria are met, the worker's status is decided instead by Labor Code §2750.5 and the Borello test. Borello is a 1989 California Supreme Court case that weighs many factors about the working relationship.

Know this

Labor Code §2750.5: a worker doing work that requires a contractor's license is presumed to be an employee. To be an independent contractor, that person must hold a valid contractor's license. An unlicensed 'sub' is treated as your employee.

Worked example

Scenario: the unlicensed drywall helper

A licensed B contractor pays an unlicensed drywall installer by the job and gives him a Form 1099.
Drywall work on the project requires a license, so §2750.5 presumes the installer is an employee.
The installer cannot meet §2781 either, because one criterion is a CSLB license.

The installer is an employee. The contractor owes payroll taxes, workers' compensation coverage, and wage-and-hour protections.

Willful misclassification is costly. Under Labor Code §226.8, the civil penalty is $5,000 to $15,000 for each violation, or $10,000 to $25,000 for each violation if there is a pattern or practice. If the violator is a licensed contractor, a certified copy of the order goes to CSLB, and the Registrar must start disciplinary action within 30 days of receiving it. EDD also warns that California gives no 'safe harbor' relief like the federal tax code, so you can owe back taxes, penalties, and interest.

Not sure? EDD's Employment Determination Guide (DE 38) helps you spot problems, and you can ask EDD for a written ruling with form DE 1870.