Contents

California's Strict Statutory ➲ 3-Part "ABC" Test

3 Situations where the "ABC" test does NOT Apply

Comparing the "ABC" & "Borello" tests ...

California's Statutory Exceptions for Specific Industries & Professions ➲ Usually Need to Apply the "Borello" Test

Applying the "Borello" Test

What are the "Borello" Factors?

Workers' Compensation

Independent Contractor ➲ California Compliance Obligations

U.S. Federal Law ➲ The IRS Test

Independent Contractor ➲ Federal Compliance Obligations

California's Strict Statutory ➲ 3-Part "ABC" Test

In California, usually (unless it is a specific situation where the "ABC" test does NOT apply, such as where the Business Owner is a member of an industry or profession which is listed as a a Statutory Exception) the Business Owner needs to apply the strict statutory 3-part “ABC" test to override the presumption that a worker is an employee, by proving all 3 elements to demonstrate the worker is an Independent Contractor.

The 3-part “ABC" test was first articulated in the 2018 California Supreme Court decision Dynamex Operations West, Inc v. Superior Court of Los Angeles, and later codified into statute under Assembly Bill 5 in 2020, commonly known as “AB 5.”

Under the “ABC" test, an individual is presumed to be an Employee, UNLESS the Business Owner can prove all 3 elements of the “ABC" test.

The Business Owner MUST be able to prove the worker:

1️⃣ Is free from control and direction of the Business Owner in connection with the performance of the work, both

⚖️ Under the contract for the performance of the work; and

⚖️ in actually doing the work;

2️⃣ Performs work that is outside the usual course of the Business Owner's business; and

3️⃣ Is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

In sum, failure to satisfy ALL 3 elements will result in an individual being classified as an Employee.

This determination applies for the purposes of the California's Labor Code, Unemployment Insurance Code, and Industrial Welfare Commission (IWC) wage orders.

3 Situations where the "ABC" test does NOT Apply

The following Q&A explaining the situations were the “ABC" test does NOT apply has been extracted from:

⚖️ The California Department of Industrial Relations ➲ Independent Contractor FAQ

Q. Do AB 5 and Labor Code sections 2775 et seq. require use of the "ABC" test in all situations?

A. No. There are situations where the "ABC" test will NOT apply:

Sometimes the Legislature or the Industrial Welfare Commission has defined the employment relationship in a specific way.

In such cases, the ABC test will not otherwise apply to establish employee status or employer liability.

1️⃣ Rather, the specific language contained in the IWC wage orders, the Labor Code, or Unemployment Insurance Code will remain in effect.

2️⃣ Additionally, where a court determines the ABC test cannot apply for a reason other than an express exception, the Borello test, will apply.

For example: If a court were to determine in a particular case that the ABC test is preempted by an applicable federal law, the Borello test would be used.

3️⃣ Finally, the ABC test may not apply for certain occupations and contracting relationships.

Comparing the "ABC" & "Borello" tests ...

The following Q&A comparing the “ABC" test to the "Borello" test has been extracted from:

⚖️ The California Department of Industrial Relations ➲ Independent Contractor FAQ

Q. How does the ABC test compare to the Borello test?

A. Both the Borello test and the ABC test assume that the worker is an employee and the hiring entity must prove that the worker is an independent contractor.

However, the ABC test is designed to make it easier for both businesses and workers to determine in advance whether a worker is an independent contractor or an employee.

In other words, it is aimed at being more predictable than the multifactor approach used under Borello.

Unlike the ABC test — in which the inability of the hiring entity to demonstrate any part of the three-part test means that the worker is not an independent contractor — under the Borello test, no single factor determines whether a worker is an employee or an independent contractor.

Courts consider all potentially relevant factors on a case-by-case basis in light of the nature of the work, the overall arrangement between the parties and the purpose of the law.

California's Statutory Exceptions for Specific Industries & Professions ➲ Usually Need to Apply the "Borello" Test

The following Q&A explaining the specific industries & professions that usually need to apply the "Borello" test has been extracted from:

⚖️ The California Department of Industrial Relations ➲ Independent Contractor FAQ

1️⃣ For some occupations, the Borello test applies without further requirements.

2️⃣ However, for other occupations and industries, the Borello test applies instead of the ABC test only after the hiring entity satisfies other requirements first.

3️⃣ Finally, for certain real estate licensees and repossession agencies, standards under the California Business and Professions Code will continue to apply.

To summarise:

1️⃣ Occupations where the Borello test applies without further requirements instead of the ABC test under California Labor Code sections 2775 et seq.:

✅ Certain occupations in connection with creating, marketing, promoting, or distributing sound recordings or musical compositions

✅ Certain licensed insurance agents, brokers, and persons who provide underwriting inspections, premium audits, risk management, claims adjusting, third-party administration consistent with use of the term “third-party administrator,” as defined in subdivision (cc) of Section 10112.1 of Title 8 of the California Code of Regulations, or loss control work for the insurance and financial service industries

✅ Certain licensed physicians, surgeons, dentists, podiatrists, psychologists, or veterinarians

✅ Certain licensed attorneys, architects, landscape architects, engineers, private investigators and accountants

✅ Certain registered securities broker-dealers or investment advisers or their agents and representatives

✅ Certain direct salespersons

✅ Certain manufactured housing salespersons

✅ Certain licensed commercial fishers (only through December 31, 2025 unless extended by the Legislature)

✅ Certain newspaper distributors or carriers (only through December 31, 2024 unless extended by the Legislature)

✅ Certain persons engaged by an international exchange visitor program

✅ Certain competition judges

✅ Certain home inspectors, as defined in Section 7195 of the Business and Professions Code, and subject to the provisions of Chapter 9.3 (commencing with Section 7195) of Division 3 of that code.

2️⃣ Occupations or contracting relationships where Labor Code sections 2775 et seq. requires that additional requirements must first be met in order to use the Borello test instead of the ABC test:

⚖️ Certain professional services contracts for marketing; human resources administration; travel agents; graphic design; grant writers; fine artists; enrolled agents licensed to practice before the IRS; payment processing agents; still photographers / photojournalists; videographers; photo editors to a digital content aggregator; freelance writers, translators, editors, copy editors, illustrators, or newspaper cartoonists; content contributors, advisors, producers, narrators, or cartographers for a journal, book, periodical, evaluation, other publication or educational, academic, or instructional work in any format or media; licensed barbers, cosmetologists, electrologists, estheticians, or manicurists (manicurists only through December 31, 2024); specialized performing arts Master Class Instructors, appraisers, registered professional foresters, and data aggregators, as defined.

Borello applies to determine whether the individual is an employee of the hiring entity if initial requirements are met.

⚖️ Relationships between two individuals working on a single engagement event, defined as a stand-alone non-recurring event in a single location, or a series of events in the same location no more than once a week.

Borello applies if initial requirements are met.

⚖️ Certain individuals performing work under a subcontract in the construction industry, including construction trucking (with certain specific conditions applicable to construction trucking only through December 31, 2024).

Borello and Labor Code section 2750.5 apply to determine whether the individual is an employee of the contractor if initial requirements are met.

⚖️ Certain service providers who are referred to customers through referral agencies to provide services including, but not limited to, graphic design, web design, photography, tutoring, consulting, youth sports coaching, caddying, wedding or event planning, services provided by wedding and event vendors, minor home repair, moving, errands, furniture assembly, animal services, dog walking, dog grooming, picture hanging, pool cleaning, yard cleanup, and interpreting.

Borello applies to determine whether the service provider is an employee of the referral agency if initial requirements are met.

The following services are excluded: services provided in an industry designated as a high hazard industry, janitorial, delivery, courier, transportation, trucking, agricultural labor, retail, logging, in-home care, or construction services other than minor home repair.

⚖️ Certain individuals performing services pursuant to a third party’s contract with a motor club to provide motor club services.

Borello applies to determine whether the individual is an employee of the motor club if initial requirements are met.

⚖️ Certain bona fide business-to-business contracting relationships.

Borello applies to determine whether the business providing services is an employee of the business contracting for the services if initial requirements are met.

3️⃣ For 2 specific industries, special rules under Labor Code section 2778(b) require examination under the Business and Professions Code:

⚖️ Certain real estate licensees, for whom the test of employee or independent contractor status is governed by section 10032(b) of the Business and Professions Code.

If that section is not applicable, then Borello is the applicable test for purposes of the Labor Code, except ABC will be the applicable test for purposes of workers’ compensation as of July 1, 2020.

⚖️ Certain repossession agencies, for which the determination of employee or independent contractor status is governed by Section 7500.2 of the Business and Professions Code.

The exemptions from the ABC test for certain industries, occupations, or contracting relationships may involve some complicated rules and criteria which are not set forth above.

Business Owners and workers should seek independent advice and counsel if they have questions about the applicability of any exemption to their particular case.

Applying the "Borello" Test

If an exception applies, then courts and agencies will apply the test specified in the statutory exception, usually the "Borello" test after the California Supreme Court case it originated from, S. G. Borello & Sons, Inc. v. Department of Industrial Relations.

The "Borello" test is a more flexible factor-based test that focuses primarily on the Business Owner's right to control the manner and means of performing the work but also requires consideration of several other factors on a case-by-case basis.

What are the "Borello" Factors?

Because different tests are applied depending on the legal issue and the specific circumstances of the business, Business Owners should always consult with our legal team to make sure any workers they decide to classify as independent contractors can meet all applicable legal requirements under the applicable test.

The "Borello" test relies upon multiple factors to make that determination, including whether the potential employer has all necessary control over the manner and means of accomplishing the result desired, although such control need not be direct, actually exercised or detailed.

The control factor is not dispositive, it MUST be considered along with other factors, which include:

⚖️ Whether the worker performing services holds themselves out as being engaged in an occupation or business distinct from that of the employer;

⚖️ Whether the work is a regular or integral part of the employer’s business;

⚖️ Whether the employer or the worker supplies the instrumentalities, tools, and the place for the worker doing the work;

⚖️ Whether the worker has invested in the business, such as in the equipment or materials required by their task;

⚖️ Whether the service provided requires a special skill;

⚖️ The kind of occupation, and whether the work is usually done under the direction of the employer or by a specialist without supervision;

⚖️ The worker’s opportunity for profit or loss depending on their managerial skill;

⚖️ The length of time for which the services are to be performed;

⚖️ The degree of permanence of the working relationship;

⚖️ The method of payment, whether by time or by the job;

⚖️ Whether the worker hires their own employees;

⚖️ Whether the employer has a right to fire at will or whether a termination gives rise to an action for breach of contract; and

⚖️ Whether or not the worker and the potential employer believe they are creating an employer-employee relationship (this may be relevant, but the legal determination of employment status is not based on whether the parties believe they have an employer-employee relationship).

Borello is referred to as a “multifactor” test because it requires consideration of all potentially relevant facts – no single factor controls the determination.

Courts have emphasized different factors in the multifactor test depending on the circumstances.

For example: Where the employer does not control the work details, an employer-employee relationship may be found if:

1️⃣ The employer retains control over the operation as a whole,

2️⃣ The worker’s duties are an integral part of the operation, and

3️⃣ The nature of the work makes detailed control unnecessary. (Yellow Cab Cooperative, Inc. v. Workers’ Compensation Appeals Board (1991) 226 Cal.App.3d 1288.)

As the Supreme Court has explained, Borello “emphasizes statutory purpose as the touchstone for deciding whether a particular category of workers should be considered employees rather than independent contractors for purposes of social welfare legislation.” (Dynamex, 4 Cal.5th at 935.) 

The emphasis on statutory purpose “sets apart the Borello test for distinguishing employees from independent contractors from the [common law] standard . . . in which the control of details factor is given considerable weight.” (Id.)

Workers' Compensation

The "ABC" test is the generally applicable test for determining independent contractor status in the context of workers’ compensation.

If an exception to the "ABC" test applies, then the "Borello" test applies, focusing primarily on the hiring entity’s control over the manner and means of performing the work, along with additional factors.

Independent Contractor ➲ California Compliance Obligations

Penalties for Misclassification

Are there penalties for misclassifying workers as independent contractors?

A.Yes. In addition to penalties that may be assessed for wage violations associated with a worker being misclassified as an Independent Contractor, there are civil penalties for willful misclassification.

Under Labor Code section 226.8, which prohibits the willful misclassification of individuals as Independent Contractors, there are civil penalties of between $5,000 and $25,000 per violation.

Willful misclassification is defined as voluntarily and knowingly misclassifying an Employee as an Independent Contractor.

Independent Contractor ➲ State Reporting Obligations

All businesses and government entities that hire Independent Contractors MUST file reports with the California State Employment Development Department.

The Independent Contractor reporting program is designed to locate parents who are delinquent in their child support obligations.

Businesses operating outside California are subject to this law as well.

For example, an independent contractor who works in California for a business based in Texas MUST be reported to California's EDD.

Penalties for Late Filing or Failure to File without Good Cause

There is a penalty for each instance of late filing or failure to file the Report of Independent Contractors, unless there is good cause.

The penalty increases if there is a conspiracy between the hiring entity and the Independent Contractor not to supply the required report or to supply a false or incomplete report.

U.S. Federal Law ➲ The IRS Test

For federal tax purposes, the IRS uses 3 tests to consider in determining worker classification:

1️⃣ The Behavioral Control Test;

2️⃣ The Financial Control Test; and the

3️⃣ Relationship between the Parties.

These 3 tests consider factors similar to the common-law test, focusing on the right to control.

In each case, it is very important to consider all the facts – no single fact determines the outcome of the IRS classification.

Form SS-8

If it is still unclear whether a worker is an Employee or an Independent Contractor after reviewing the three categories of evidence, then Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, can be filed with the IRS.

The form may be filed by either the Business Owner or the worker.

The IRS will review the facts and circumstances and officially determine the worker’s status.

Be aware that it can take at least 6 months to get a determination.

A Business Owner that continually hires the same types of workers to perform particular services may want to consider filing the Form SS-8

Federal Taxes and Independent Contractors

The IRS is the federal taxing authority that determines whether an employment relationship exists between a worker and Business Owner that requires payment of federal employment taxes, including Social Security taxes, payment under the Federal Unemployment Tax Act and withholding of worker-owed employment taxes.

Misclassification of bona fide employees as independent contractors may result in the federal government collecting significant financial penalties from employers and the IRS aggressively auditing companies to expose abuses.

It is estimated that as much as $1.5 billion in income, Social Security withholdings and unemployment tax revenue is lost annually due to misclassification of as many as 3.5 million workers as independent contractors.

Companies judged by the IRS to have misclassified employees as independent contractors face not only large government fines but also payment of employment taxes.

Independent Contractor ➲ Federal Compliance Obligations

Any business or government entity (including nonprofit organisations) making payments for service performed by an Independent Contractor (who is not a Corporation# or an International Contractor^) is most likely required (unless an exception applies) by 31 Jan each year to:

1️⃣ File IRS Form 1099-NEC; AND 

2️⃣ Furnish a statement to the Recipient.

*When is IRS Form 1099-NEC (Non-Employee Compensation) required to be filed?

If the following 4 conditions are met, you MUST generally report a payment as NEC:

1️⃣ You made the payment to someone who is not your Employee (ie., an Independent Contractor excluding International Contractors^);

2️⃣ You made the payment for services in the course of your trade or business (including government agencies and nonprofit organizations);

3️⃣ You made the payment to an individual, partnership, estate, or, in some cases, a Corporation#; and

4️⃣ You made payments to the payee of at least $600 during the year.

For each person to whom you have paid at least $600 for the following during the year (Form 1099-NEC):

✅ Services performed by someone who is not your employee (including parts and materials); or

✅ Payments to an attorney (including law firms or other providers of legal services).

Notes:

 You MUST File Form 1099-NEC or Form 1099-MISC to report sales totaling $5,000 or more of consumer products to a person on a buy-sell, a deposit-commission, or other commission basis for resale.

 You MUST also file Form 1099-NEC for each person from whom you withheld any Federal Income Tax (Box 4 of Form 1099-NEC) under the backup withholding rules regardless of the amount of the payment.

# When MUST Payments to Corporations be Reported?

The exemption from reporting payments made to Corporations does not apply to payments for:

✅ Legal services (Box 1 of Form 1099-NEC or Box 10 of Form 1099-MISC);

✅ Cash payments for the purchase of fish for resale (Box 11 of Form 1099-MISC);

✅ Medical and health care payments (Box 6 of Form 1099-MISC), or

✅ Substitute payments in lieu of dividends or tax-exempt interest (Box 10 of Form 1099-MISC); or

✅ Payments made by a Federal executive agency.

For more examples and exceptions relating to payments to attorneys, see Regulations section 1.6045-5.

Refer to our FAQ: When is IRS Form 1099-MISC, 1099-NEC or some other variant of Form 1099 required to be filed? and the instructions for both IRS Form 1099-NEC & IRS Form 1099-MISC for more information.

10 or More IRS Information Returns ➲ E-filing Now Required!

Starting tax year 2023, if you have 10 or more information returns, you MUST file them electronically.

This includes Forms W-2, e-filed with the Social Security Administration.

Find details on the final e-file regulations and requirements for Forms W-2.

To e-file, apply now for a Transmitter Control Code (TCC).

It may take up to 45 days for processing.

You can e-file any Form 1099 for tax year 2022 and later with the Information Returns Intake System (IRIS).

The system also lets you file corrections and request automatic extensions for Forms 1099.

For system availability, check IRIS status.

There are 2 ways to e-file with IRIS.

Source: E-file Forms 1099 with IRIS

Resolving Irregularities

If you are a recipient or payee of an incorrect Form 1099-NEC contact the payor.

If you cannot get this form corrected, attach an explanation to your tax return and report your income correctly.

If you are a recipient or payee expecting a Form 1099-NEC and have not received one, contact the payor.

Not Required to File 1099 Information Returns

You are not required to file information return(s) if any of the following situations apply:

⚖️ You are not engaged in a trade or business.

⚖️ You are engaged in a trade or business; and

❌ The payment was made to another business that is incorporated, but was not for medical or legal services;

❌ The sum of all payments made to the person or unincorporated business is less than $600 in one tax year; or

❌ ^ The payment was made to an International Contractor (not a US-Citizen) performing services outside the U.S.

Payments to an International Contractor

A U.S. company engaging an International Contractor should request an IRS Form W-8BEN/W-8BEN-E be completed and submitted by the foreign contractor. We recommend you ensure it is prepared fully and accurately and is signed and dated by the contractor.

The W8BEN-E is not submitted to the IRS, but it should be kept by the hiring company to certify the contractor’s foreign status in the event the IRS questions why taxes were not withheld.

Further Reading:

California Department of Industrial Relations ➲ Independent Contractor FAQ

CalChamber ➲ Independent Contractor v. Employee

IRS ➲ Independent Contractor (Self-Employed) v. Employee?

The IRS Test Brochure ➲ 3 Tests to Consider

IRS ➲ Am I Required to File a Form 1099 or Other Information Return?

‍Social Sharing Image: Courtesy of Brett Jordan on Unsplash

Credits: This blog article was written by James D. Ford Esq., GAICD CIPP/US CC | Attorney-at-Law, Blue Ocean Law Group℠.

Important Notice:

This blog article is intended for general interest + information only.

It is not legal advice, nor should it be relied upon or used as such.

We recommend you always consult a lawyer for legal advice specifically tailored to your needs & circumstances.