Worker misclassification is one of the most expensive legal mistakes a California employer can make, and it remains a high-enforcement priority in 2026. California's AB5, which took effect in January 2020, fundamentally changed how businesses classify workers by codifying the ABC test and extending it across the Labor Code and Unemployment Insurance Code. For San Diego businesses that rely on independent contractors, understanding how this law works and where the exemptions apply is not optional. It is essential.
The ABC Test: What It Requires
Under AB5, all workers in California are presumed to be employees unless the hiring business can satisfy all three prongs of the ABC test simultaneously. Failing even one prong automatically classifies the worker as an employee entitled to minimum wage, overtime, workers' compensation, and other Labor Code protections.
The first prong requires that the worker is free from the hiring entity's control and direction in performing the work, both under the contract and in fact. The second prong requires that the worker performs work outside the usual course of the hiring entity's business. The third prong requires that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
The second prong is the most frequently litigated. If a business hires a worker to perform services that are central to what the business does, such as a graphic designer hired by a marketing agency, this prong is not satisfied, and the worker must be classified as an employee.
Exemptions and the Borello Test
AB5 was substantially amended by AB 2257 in 2020, which added over 100 categories of workers exempt from the ABC test. These exemptions cover many licensed professionals, including doctors, lawyers, architects, accountants, and insurance brokers, among others. Workers in exempt categories are instead evaluated under the older Borello test, a multi-factor analysis that California courts have applied for decades.
The Borello test considers factors such as whether the hiring entity controls how work is performed, whether the worker provides their own tools and equipment, whether the work is integral to the employer's business, and whether the worker has an opportunity for profit or loss.
For many San Diego businesses, particularly those in construction, creative services, technology, and professional services, the exemptions are navigable, but they require careful legal analysis. Assuming your contractor arrangement qualifies for an exemption without confirming it is a compliance risk.
The Cost of Getting It Wrong
The penalties for worker misclassification under AB5 are substantial. Civil penalties range from $5,000 to $15,000 per violation and can reach $25,000 per violation where a pattern of willful misclassification is found.
Beyond civil penalties, a misclassified employee may be entitled to back wages, unpaid overtime, missed meal and rest period premiums, unreimbursed business expenses, and the employer's share of employment taxes. Class action exposure multiplies these risks significantly for businesses with multiple contractors in similar roles.
The Labor Commissioner's Office, the Employment Development Department, and plaintiffs' attorneys in California actively pursue misclassification claims. A finding that your independent contractors are actually employees can expose your business to retroactive liability covering the entire period of misclassification.
What San Diego Employers Should Do Now
The most effective approach is a proactive audit of all existing contractor relationships. For each contractor, document why the arrangement satisfies all three prongs of the ABC test, or confirm which exemption applies and why. Review independent contractor agreements to ensure they accurately reflect the relationship and do not inadvertently evidence employee-like control. Update agreements to include provisions that support independent status, such as the contractor's right to work for multiple clients, their use of their own tools, and their ability to accept or reject work.
For businesses that discover misclassification issues during an audit, voluntary correction is almost always less costly than waiting for a government investigation or private lawsuit. An employment attorney can help you restructure contractor relationships, convert workers to employee status where appropriate, and document the rationale for each classification going forward.
At Bayside Counsel, we help San Diego employers navigate AB5 compliance, from contractor audits and agreement drafting to defending misclassification claims. Contact us to schedule a consultation before a problem becomes a lawsuit.