AB 5 Exemptions: What California Businesses Need to Know About Worker Classification

A woman reading a book

Why Worker Classification Matters Under AB 5

The ABC Test for Independent Contractors

AB 5 became effective on January 1, 2020 and significantly reshaped California’s worker classification rules. The law introduced the ABC test as the standard for determining whether a worker can be treated as an independent contractor.

Under the ABC test, a worker may be classified as a contractor only if all three of the following conditions are satisfied:

  • The worker is free from the hiring entity’s control and direction in performing the work
  • The work performed is outside the usual course of the hiring entity’s business
  • The worker is customarily engaged in an independently established trade, occupation, or business

If a business cannot satisfy each element of this test, the worker must generally be classified as an employee.

The Financial Risks of Worker Misclassification

Misclassification can lead to serious consequences. Businesses may face assessments from the California Employment Development Department, the IRS, and other state agencies. Those assessments can include:

  • Unpaid payroll taxes
  • Penalties and interest
  • Workers’ compensation exposure
  • Additional regulatory liabilities

AB 5 Exemptions Do Not Remove Classification Requirements

How the Borello Test Applies to Exempt Industries

Many industries received exemptions under AB 5. These exemptions allow certain professional relationships to be evaluated under the Borello test instead of the ABC test.

The Borello test examines multiple factors to determine whether a worker is truly operating independently. The analysis focuses on the overall relationship between the hiring company and the contractor, including:

  • How the work is performed
  • Who controls the process
  • Whether the contractor operates an independent business

An exemption changes the legal framework used to evaluate classification. It does not guarantee that a worker can be treated as a contractor.

Occupational Exemptions Under AB 5

Licensed Professional Occupations

AB 5 includes several professional exemptions that apply to specific occupations when certain requirements are met.

Examples include:

  • Doctors, surgeons, dentists, podiatrists, psychologists, and veterinarians providing professional services through health care entities
  • Lawyers, architects, engineers, insurance brokers, private investigators, and accountants
  • Securities brokers and investment advisers registered with the SEC, FINRA, or the State of California
  • Real estate agents, repossession agencies, direct sales representatives, and commercial fishermen
  • Individuals performing services under contracts with licensed motor clubs

Professional Services Exemptions

Independent Professional Categories

Certain independent professionals may qualify for AB 5 exemptions if their work relationship meets specific statutory conditions.

These categories include:

  • Marketing professionals
  • Human resources professionals
  • Travel agents
  • Graphic designers and graphic artists
  • Fine artists
  • Freelance writers
  • Barbers and cosmetologists
  • Estheticians, electrologists, and manicurists
  • Payment processing agents
  • IRS licensed tax professionals

Even within these professions, the structure of the relationship matters. Factors that influence classification include:

  • Payment structure
  • Level of control over work
  • Evidence of operating an independent business

Referral Agency Exemptions

Services Commonly Provided Through Referral Platforms

AB 5 also includes exemptions for certain services provided through referral agencies. These typically involve individuals offering services directly to consumers while using a platform or agency to obtain work opportunities.

Examples include:

  • Graphic design
  • Photography
  • Tutoring
  • Event planning
  • Moving services
  • Minor home repairs
  • Home cleaning
  • Errand services
  • Furniture assembly
  • Animal services including dog walking and grooming
  • Web design
  • Picture hanging
  • Pool cleaning
  • Yard cleanup

These exemptions depend on the structure of the referral relationship and the independence of the service provider.

Construction Industry Exemptions

Requirements for Construction Subcontractors

The construction industry includes a limited exemption for certain subcontractor relationships. However, this exemption carries several additional requirements.

For a subcontractor relationship to qualify:

  • The subcontract agreement must be in writing
  • The subcontractor must hold the appropriate contractor’s license through the Contractors State License Board
  • The subcontractor must operate an independently established trade such as a carpenter, electrician, or plumber

Additional Compliance Requirements in Construction

Additional factors may also apply, including:

  • Maintaining a separate business location from the hiring entity
  • Hiring and supervising their own employees
  • Accepting financial responsibility for mistakes through warranties, indemnity agreements, insurance, or bonding

Construction classifications receive particular scrutiny during EDD audits because of the industry’s heavy reliance on subcontractors.

Why EDD Audits Often Focus on Contractor Classification

How Worker Classification Is Evaluated During an Audit

California enforcement agencies continue to monitor worker classification closely. When a company relies heavily on contractors, auditors often examine whether those relationships meet the legal standards required for independent status.

During an audit, agencies may review:

  • Contracts
  • Invoices
  • Payment records
  • Communications
  • Operational practices

Auditors evaluate whether the contractor maintains an independent business and whether the hiring entity exercises control over the work.

How Businesses Can Strengthen Contractor Compliance

Documentation That Supports Independent Contractor Status

Businesses that rely on contractors can reduce classification risk by reviewing several key areas:

  • Written agreements that clearly define the contractor relationship
  • Evidence that the contractor operates an independent business
  • Documentation showing that the contractor controls how work is performed
  • Licensing, insurance, and business registration records
  • Consistent payment structures and invoicing practices

EDD Audit Defense for Worker Misclassification

When Businesses Should Seek Professional Guidance

Worker classification disputes often arise during EDD audits or investigations. These audits can expand quickly once agencies begin reviewing payroll records and contractor arrangements.

Milikowsky Tax Law has resolved more than 300 EDD audits and investigations for California business owners. If your business:

  • Works with multiple contractors
  • Falls within an AB 5 exempt category
  • Has received contact from the EDD regarding an audit

Reviewing your classification structure early can help protect your business as enforcement continues to evolve.