What the ABC Test Is

The ABC test is California’s statutory standard for determining whether a worker is an employee or an independent contractor under the California Unemployment Insurance Code, the Labor Code, and state tax law.

Before 2018, California used a multifactor test drawn from S. G. Borello & Sons, Inc. v. Department of Industrial Relations (1989). The central question was whether the hiring entity had the right to control the manner and means of the work. It was flexible, contextual, and frequently litigated — often with results that favored businesses that had structured their contracts carefully.

The California Supreme Court changed the framework in Dynamex Operations West, Inc. v. Superior Court, 4 Cal. 5th 903 (2018). The court held that a simpler, more worker-protective test was appropriate for wage order purposes — and that the burden of proving independent contractor status falls on the hiring entity. The Legislature then codified that test in AB5 (Assembly Bill 5), adding it to Labor Code § 2775, effective January 1, 2020. AB5 later became AB 2257, which added and revised a range of industry-specific exemptions, but the core test did not change.

The default rule under the ABC test is this: every worker is presumed to be an employee. If you want to treat someone as an independent contractor, you must prove all three prongs — A, B, and C. The failure of any single prong means the worker is an employee for that purpose, regardless of what your contract says.

The Three Prongs in Detail

All three prongs must be satisfied — not two out of three, all three. Here is what each one requires in practice.

Prong A — Freedom from Control

The worker must be free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract and in fact. This tracks the traditional common-law control test. The hiring entity cannot dictate when the worker shows up, what tools they use, how they complete the task, or where they do the work.

Prong A is usually the easiest to satisfy on paper — many contractor agreements are written to address control. What the EDD actually looks at is the day-to-day reality of the relationship, not the contract language. If your contractor works set hours, uses company equipment, attends required staff meetings, and is subject to supervision, the control prong is in trouble regardless of what the agreement says.

Prong B — Outside the Usual Course of Business

Prong B requires that the worker performs work that is outside the usual course of the hiring entity’s business. This is the hardest prong to satisfy, and it is where the majority of EDD misclassification assessments are built.

The logic is straightforward: if the work you are hiring someone to do is the same work your business exists to do, that person is almost certainly an employee. A driver working for a delivery company, a nurse placed by a healthcare staffing agency at a hospital, a software developer contracted to a software firm, a writer hired by a media company — in each case, the contractor is performing the core function of the business. Prong B fails. The worker is an employee.

The EDD examines Prong B by looking at what services the worker provided and what the business’s primary activity is. Their analysis is outlined in DE 38 (Employment Determination Guide), which sets out the agency’s formal framework. The question is not whether your business sometimes hires out for services — it is whether the services in question are integral to what you do.

Businesses with large contractor workforces should do a Prong B analysis for each class of worker before the EDD does it for them. If a class of worker fails Prong B, the question shifts to whether an exemption applies.

Prong C — Independent Business

The worker must be customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed. This means more than a contractor agreement and a W-9.

The worker should have their own business entity, maintain their own business infrastructure, work for multiple clients in the same field, and hold themselves out to the market as an independent business — not as an extension of your organization. A worker who has one client (you), works exclusively for your business, and has no independent market presence has a weak Prong C claim even if they have an LLC and a website.

Who Enforces the ABC Test and When

Three separate California agencies apply the ABC test, each with independent audit authority and its own assessment process.

The California Employment Development Department (EDD) uses the ABC test for payroll tax purposes under the California Unemployment Insurance Code. An EDD audit of worker classification results in assessments for unpaid UI (unemployment insurance), ETT (employment training tax), SDI (state disability insurance), and PIT (personal income tax) withholding — for each quarter in the audit period. The EDD has broad subpoena authority and regularly requests payroll records, contracts, invoices, and operational details when examining a business’s contractor relationships.

The California Labor Commissioner (Division of Labor Standards Enforcement) applies the ABC test in wage and hour claims under the Labor Code. A misclassification finding at the Labor Commissioner level can trigger back wages, overtime, meal and rest period premiums, and waiting time penalties under Labor Code § 203.

The California Franchise Tax Board (FTB) applies the ABC test for income tax withholding purposes. If a worker was misclassified, the business may owe California income tax withholding it failed to collect and remit.

These proceedings are independent. An EDD audit does not preclude a Labor Commissioner claim, and a settlement with one agency does not bind another.

Prong B: The Common Failure Point

The EDD focuses almost exclusively on Prong B when it audits worker classification.

This is not an accident. Prong B was designed to be more protective of workers than the traditional Borello control test. It places the burden on the hiring entity, and it asks a question that is hard to answer favorably when your business model depends on contractor labor in your core function.

The most common Prong B failures we see:

• Gig economy platforms that classify drivers, couriers, or service workers as independent contractors when those workers are performing the company’s primary service.
• Staffing arrangements where the contractor performs work that the client business bills to its own customers as its primary service.
• Construction general contractors who subcontract trades that are integral to their bid scope.
• Professional services firms (law firms, accounting firms, consulting firms) that use contractor professionals to deliver billable client services.
• Tech companies that hire contract software developers to build their products.

If your business falls into one of these categories and has not analyzed Prong B, you are carrying exposure. The EDD’s audit horizon is three years under the standard statute of limitations, and six years if the EDD finds substantial underreporting.

Exemptions Under AB5

AB5 includes a series of exemptions that allow certain workers and business relationships to be evaluated under the older Borello test rather than the ABC test. These exemptions are in Labor Code §§ 2776–2784, and they are specific — the general rule is ABC; the exemption is the exception.

The most commonly applicable exemptions include:

Professional services exemption (§ 2776(a)): Covers specific licensed professions, including licensed architects, engineers, attorneys (in certain representations), accountants, securities dealers, investment advisers, licensed physicians, certain registered nurses, and others listed in the statute. If the professional services exemption applies, the Borello multifactor test applies instead of the ABC test.

Business-to-business (B2B) contracting exemption (§ 2776(b)): This exemption applies when a business entity (not an individual) contracts with another business entity. To qualify, the contracting entity must: (1) be formed as a business entity, (2) maintain a business location separate from the hiring business, (3) have a business license or business tax registration, (4) operate under a written contract that specifies the services to be performed and the compensation to be paid, (5) have the ability to set or negotiate its own rates, (6) perform the services under its own name and not as an employee of the hiring business, (7) maintain its own tools, vehicles, or equipment, (8) maintain liability insurance of at least $1 million, (9) provide services to other clients, and (10) satisfy the ABC test’s Prong A and Prong B criteria independently. The B2B exemption is available but it is not a checklist formality — all conditions must be met.

Referral agency exemption (§ 2781): Applies to certain referral agency arrangements in specified service categories (tutoring, pet services, event planning, graphic design, photography, certain other services), subject to conditions including worker control over rates, hours, and client acceptance.

Specific industry exemptions: Real estate licensees, direct sales representatives, certain commercial fishermen, and app-based transportation network company (TNC) drivers under Proposition 22 (approved by voters in November 2020) have full or partial exemptions from the ABC test. These are industry-specific and operate under their own frameworks.

Freelancer categories: Musicians, musical contractors, recording artists, and certain other entertainment and creative workers have partial exemptions subject to AB 2257 conditions.

A business that relies on an exemption and is later found not to qualify faces the full consequences of ABC test misclassification — the exemption argument does not limit liability. If you are relying on an exemption, it should be documented and analyzed before an audit, not during one.

Consequences of Misclassification

A finding of worker misclassification by the EDD results in back payroll taxes for every quarter in the audit period, plus penalties and interest — and personal liability for responsible officers is available under the CUIC.

The specific assessments an EDD audit can generate:

• Back UI, ETT, SDI, and PIT withholding: For each quarter where workers were misclassified, the EDD calculates what should have been withheld and remitted. Depending on how many workers were affected and for how long, these numbers can be substantial.
• Late payment penalty under CUIC § 1112: Ten percent of the unpaid taxes.
• Willful misclassification penalties under Labor Code § 226.8: For violations found to be intentional, a civil penalty of $5,000 to $15,000 per violation (and $10,000 to $25,000 per violation if there is a pattern or practice). The business and any person who advises the business to engage in the misclassification can both be held liable.
• Personal liability under CUIC § 1735: Responsible officers — owners, officers, and members with significant control over employment decisions — can be held personally liable for unpaid employment taxes. This is not dischargeable in bankruptcy.

The standard statute of limitations for an EDD assessment is three years from the end of the calendar quarter in which the wages were paid. That period extends to six years for fraud or willful failure to file. There is no limitation period if the EDD finds the employer failed to file required returns.

Worker misclassification also generates exposure at the Labor Commissioner. The interaction between an EDD audit and a concurrent Labor Commissioner proceeding can compound quickly — the same set of facts can produce parallel assessments from two agencies covering overlapping (but not identical) categories of liability.

The Borello Test (for Exempted Categories)

For workers who fall within an AB5 exemption, California applies the Borello multifactor test — the pre-Dynamex framework drawn from S. G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989).

The Borello test centers on the fundamental question of whether the hiring entity had the right to control the manner and means by which the worker accomplished the result. But control is not the only factor. Courts and the EDD also consider:

• Whether the hiring entity has the right to discharge the worker at will
• Whether the worker is engaged in a distinct occupation or business
• Whether the work is usually done under the direction of a principal or by a specialist without supervision
• The skill required for the work
• Whether the worker supplies their own tools, equipment, and place of work
• The length of time for which services are to be performed
• Whether the work is part of the regular business of the principal
• Whether the parties believe they are creating an employment relationship
• Whether the principal is or is not in business

Under Borello, no single factor is determinative, and the analysis requires weighing the totality of the relationship. This gives businesses more flexibility than the ABC test — but also more uncertainty. An ABC test failure is binary; a Borello analysis requires judgment, and the EDD’s judgment may differ from yours.

If your workforce includes workers in exempted categories and you are relying on Borello, the analysis should be documented for each worker class. The EDD does not accept verbal assurances of independent contractor status, and a contractor agreement drafted without a Borello analysis behind it is not a defense.

How Brotman Law Helps

Most EDD audits are worker classification audits. The question in nearly every one of them is whether your independent contractors should have been treated as employees under the ABC test — specifically whether Prong B fails. The EDD does not send letters to businesses that have this question obviously resolved in their favor.

We work with businesses at two stages. Before an audit: analyzing each class of worker, identifying which prongs are at risk, documenting available exemptions, and structuring contractor relationships to withstand scrutiny. After an audit notice: representing the business through the EDD’s examination, challenging the scope of the proposed assessment, and litigating the classification question where there is a real argument to make.

If you have received an EDD audit notice, or if you are running a business with significant contractor relationships and have not done a formal ABC test analysis, book a free 15-minute call. We can tell you quickly whether you have a problem and what the realistic options are.

Sam Brotman, J.D., LL.M. (Taxation), MBA
Brotman Law | Last updated June 2026