In 2022, the California Employment Development Department (EDD) identified approximately 158,000 misclassified workers through audits and inspections. Since then, the EDD has continued to battle misclassification between employees and independent contractors, and employers can expect to see a spike in 1099 audits specifically. While there is no guidance to determine which businesses will be selected for an audit, a common error is when an independent contractor files for unemployment.

It is important to understand how independent contractors are treated for tax purposes as compared to employees. To determine whether California workers are classified as employees or independent contractors, the ABC Test is recommended in accordance with California Assembly Bill 5 (AB 5). Per the EDD, a worker is considered an employee and not an independent contractor unless the hiring entity meets all three conditions of the ABC test:

 Employee Independent Contractor
Guided by management’s input Free from control and direction (independent) of the hiring entity’s input on work performance
Performs work in the hiring entity’s usual business Performs work outside the scope of the hiring entity’s usual business
Person does not routinely work in established independent trade for which the hiring entity requested work Person routinely works in established independent trade for which the hiring entity requested work

In 2020, AB 2557 was signed and exempts certain professions and occupations from California’s restrictive ABC test for independent contractor status in the entertainment industry. Of course, there are multiple factors and tests to make the employee or independent contractor determination, so AB 2557 does not mean employers can declare anyone an independent contractor. Labor laws can change over time through new legislation and court rulings. The Client Accounting Services (CAS) team at KROST has experts in various industries who are available to consult with and provide guidance.

Please note that workers are considered employees unless proven otherwise. If workers are misclassified as independent contractors, the penalties can be extensive, with up to $25,000 per violation, as well as penalties and interest on payroll taxes. To stay ahead of the game, we recommend reviewing each independent contractor with the ABC Test and confirming if any special rules apply to your industry. If a worker classification appears incorrect, KROST can advise you on the next steps to take toward treatment.

Please contact us if you have any questions or need assistance with reviewing your worker classification.

Co-Authors: Andrea Bonilla, CPA & Amber Tabata

Sources:
1 California Employee Development Department “Payroll Taxes AB 5”.
2 California Franchise Tax Board “Worker classification and AB 5”.
3 California Department of Industrial Relations “Independent contractor versus employee”.
4 Shaw Law Group “AB 2557 – CA’s “improved” Independent Contractor Law, Explained”.


About the Author

Andrea Bonilla, CPA, ManagerAndrea Bonilla
Accounting, Client Account Services (CAS), Sports & Entertainment
Andrea Bonilla is an Accounting Manager at KROST. She has been in the public accounting profession for over four years, servicing clients in manufacturing, entertainment, restaurant, retail, and professional services. » Full Bio