“1099 vs W2” in California – A Quick Legal Guide

In California, if you report your income on a Form 1099, you are an independent contractor, while if you report it on a W-2 form, you are an employee.

Payroll taxes are automatically withheld if you are a W-2 employee; meanwhile, if you are an independent contractor, you are responsible for paying them. If you are a W-2 employee, you can also receive employment benefits, such as worker’s compensation and minimum wage protections.

California law on this topic is changing rapidly, as lawmakers struggle to keep up with the gig economy. Employers who pay you as independent contractors but treat you like employees can be held liable for worker misclassification.

In this article I answer frequently-asked-questions about employees, independent contractors, and related topics. Also listen to our informative podcast:

What is an independent contractor?

If you are an independent contractor, you take jobs on a freelance basis. You are paid by your clients using Form 1099.

You have freedom in how and when you work. You are not tied to a single boss or company. Instead, you can take jobs from a variety of different clients, even from clients who are in competition with each other. You often work on numerous short-term or part-time projects or assignments.

What is an employee?

If you are an employee, you have entered an employment agreement with your employer and are paid a regular salary, hourly wage and/or commission. You are paid by your employer using Form W-2.

You are tightly restricted in what you do while on the job. Your boss can tell you what to do and how to do it. You may work full-time hours or part-time in your position.

What are the differences between the two?

Legally, the difference between an employee and an independent contractor is that an employee is covered by many provisions of California’s Labor Code, while independent contractors are not.

This has a list of widespread, practical effects. They include:

	Employees	Independent Contractors
Payroll taxes	Payroll taxes are automatically withheld	You have to pay your own payroll taxes to the IRS on your income tax return
Workers’ compensation	Most employers in California are legally required to cover you with workers’ compensation	You are responsible for your own workers’ compensation coverage
Minimum wage laws	Covered	Not covered
Social Security and Medicare taxes	Automatically withheld by the employer	You have to pay your own Social Security and Medicare taxes to the IRS
Unemployment insurance	Covered	Not eligible for unemployment benefits
Employment taxes	You do not have to pay employment taxes	You have to pay self-employment taxes because the IRS sees you as your own employee
Health insurance	Eligible for employer-provided healthcare	Have to provide your own health insurance
Wage and hour laws	Covered	Not covered
Overtime pay	Eligible	Not eligible
Meal and rest breaks	Entitled to rest and meal breaks	Not entitled to paid breaks
Employer liability	The employer is generally held liable for damages from your negligence	You are liable for your own mistakes

The general theme is that if you have employee status, you have a firm employment relationship, while if you are an independent contractor, you have far more freedom.

What is California employment law’s “ABC test”?

For most issues, California uses the ABC test to distinguish an employee from an independent contractor. The test focuses on your:

• Autonomy – If you are sufficiently free from the control of the company hiring you, then you may be an independent contractor.
• Business – If you perform work that is outside the usual course of the hiring entity’s business, then you may be an independent contractor.
• Custom – If you are customarily engaged in a business of the same nature of the work being performed, then you may be an independent contractor.¹

If there is a worker classification dispute, the party that hired you has the burden of proving that you are not an employee.² They have to prove this with more than a mere contract that states that you are not an employee.³ Instead, they have to show that, in practice, you satisfied the ABC test.

 

History of the ABC Test

The test was created through common law by the California Supreme Court in Dynamex Operations West, Inc. v. Superior Court in 2018.⁴ It overruled an earlier case, S.G. Borello & Sons, Inc. v. Dept. of Industrial Relations,⁵ in order to clarify California employment law and prevent the growing problem of worker misclassification in the gig economy, particularly by ridesharing companies like Uber and Lyft.

Exemptions to the ABC Test

The state of California has since passed a new Labor Code section adopting the ABC test for worker classification issues. The new law, however, also recognized numerous exemptions to the test, including for:

• registered securities broker-dealers,
• licensed insurance agents,
• licensed medical professionals who work for a healthcare entity, including doctors, surgeons, and dentists,
• direct salespersons,
• licensed contractors,⁶ and
• certain bonafide business-to-business contracting relationships.⁷

If one of these exemptions applies, worker classification is determined using the old law, which uses the manner and means test. Courts look to whether the company has a right to control the manner and the means of the performance of your work.⁸

Applicability to California Law

The ABC test tends to classify more workers as employees than federal law does, providing California workers more protection than in other states. However, it only applies to employment disputes arising from California’s:

• Labor Code,
• Wage Orders, or
• Unemployment Insurance Code.⁹

Does Assembly Bill 5 or Assembly Bill 2257 impact the ABC test?

Assembly Bill 5 was the 2019 California state law that adopted the ABC test for worker classification. Assembly Bill 2257 was signed by Governor Newsom and went into effect on September 4, 2020, to clarify the earlier law.

Both of these bills carved out numerous exemptions to the ABC test, allowing more workers to be classified as independent contractors in certain industries where it was customary, such as the music recording business in Los Angeles or in law firms.

What happens if I am misclassified?

Companies who misclassify you by labeling you as an independent contractor, but treating you as an employee, can face legal action. If you have been misclassified, you can file a wage and hour lawsuit and recover compensation for the benefits that you were entitled to receive. This includes:

• unpaid overtime,
• unpaid wages for rest and meal breaks or minimum wage violations,
• attorney’s fees,
• penalties, and
• interest on unpaid wages.

If the misclassification was willful, the employer can face a civil penalty of between $5,000 and $15,000 for each violation. If there was a pattern and practice of willful misclassification, the fines go up to between $10,000 and $25,000.¹⁰

Requesting a Classification Determination

You can request a classification determination by the California Employment Development Department (EDD) if you suspect that you are being misclassified.

Additional Resources

Refer to the following IRS articles:

• About Form W-2, Wage and Tax Statement – Explanation of W-2 forms.
• About Form 1099-NEC, Nonemployee Compensation – Explanation of 1099 forms.
• Am I Required to File a Form 1099 or Other Information Return? – Discussion of when 1099 forms are necessary.
• What’s the difference between a Form W-2 and a Form 1099-MISC or Form 1099-NEC? – Comparison of the primary tax forms.
• When would I provide a Form W-2 and a Form 1099 to the same person? – Circumstances where you are an employee and an independent contractor to the same company.

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