Avoid Misclassification: Independent Contractor Or Employee?

TL;DR:

Misclassifying workers as independent contractors instead of employees can trigger serious legal consequences in California, especially in Los Angeles. Under AB5 and the California Supreme Court’s Dynamex decision, most workers are presumed to be employees unless strict criteria are met. Employers must apply the “ABC test” when making classifications, or risk lawsuits, penalties, and back wages. Understanding these rules is critical to managing compliance and litigation exposure.

In California, the line between an “employee” and an “independent contractor” isn’t just blurry, it’s fraught with legal landmines. If you run a business in Los Angeles or elsewhere in the state, misclassifying a worker can cost you more than just back pay. It could open the door to civil litigation, penalties, tax audits, and class action lawsuits.

Let’s break down the legal landscape, particularly AB5 and the Dynamex decision, so you can spot the risks and take action.

The Stakes Of Misclassification In California

Employee classification affects nearly every corner of your legal and financial responsibilities as an employer. It determines whether a worker is entitled to minimum wage and overtime. It also tells whether the worker qualifies for workers’ compensation and unemployment benefits. Additionally, it triggers health care obligations under the Affordable Care Act.

Finally, it dictates how taxes are withheld and what employer contributions are required. Misclassify a worker, and you risk violating multiple state and federal laws simultaneously.

In California, the law presumes a worker is an employee, and puts the burden on you to prove otherwise. Get it wrong, and you’re facing:

• Back pay for overtime and missed breaks.
• IRS and EDD penalties.
• Class actions under the Private Attorneys General Act (PAGA).
• Exposure to civil litigation for wrongful termination or wage theft.

Misclassification isn’t just a paperwork error, it’s a legal minefield. The consequences can cascade across multiple fronts: wage claims, tax audits, insurance disputes, and even class action lawsuits. In a state as aggressive as California when it comes to worker protections, ignorance of the rules is no defense.

To stay compliant, you need to understand the legal framework behind classification, starting with the Dynamex decision that reshaped California labor law.

The Dynamex Decision: Where It All Changed

In 2018, the California Supreme Court issued a game-changing opinion in Dynamex Operations West, Inc. v. Superior Court. It established the ABC test to determine whether a worker is an independent contractor:

A: The worker is free from control and direction in performing the work.
B: The worker performs work outside the usual course of the hiring entity’s business.

C: The worker is customarily engaged in an independently established trade or business.

If you can’t prove all three, the worker is legally an employee.

This new standard replaced the older, fuzzier Borello test, which balanced multiple factors and gave more leeway to businesses.

In 2020, the legislature passed Assembly Bill 5 (AB5), which enshrined the ABC test into law (Labor Code § 2775 et seq.). AB5 expands Dynamex’s reach beyond wage orders and applies it to Labor Code and Unemployment Insurance Code matters, meaning more potential penalties.

It also carved out exemptions for certain professionals, such as lawyers, doctors, architects, but even they must pass a modified Borello analysis. In Los Angeles CA, that means:

• Rideshare companies like Uber and Lyft had to redesign their policies or face lawsuits.
• Freelancers must often cap their work at 35 submissions per outlet to avoid triggering reclassification.
• Local agencies aggressively enforce AB5 with audits and fines.

AB5 didn’t just clarify the rules, it expanded their reach and intensified the stakes. By embedding the ABC test into multiple areas of the law, California made it harder for businesses to sidestep employee obligations through contractor labels.

And in cities like Los Angeles CA, where enforcement is robust and scrutiny is high, relying on outdated practices can backfire fast. That’s why every employer needs a clear roadmap for compliance, and that starts with taking concrete, proactive steps.

What Employers Must Do Now

So, how do you stay out of the crosshairs? It starts with action. Compliance isn’t passive, it’s a series of deliberate choices that reduce your litigation risk and keep your business above board. Whether you’re managing a startup in Los Angeles or a statewide operation, here are the key steps to protect your company under AB5 and Dynamex.

✅ Audit Your Workforce

Before anything else, take a hard look at how your workers are classified today. Go beyond job titles and contracts, examine how much control you exert, and whether their roles align with your core business. If the ABC test exposes gaps, it’s time to reclassify.

✅ Update Contracts & Policies

Even where workers legitimately qualify as independent contractors, your contracts must reflect that. Clear deliverables, independent work expectations, and strong indemnity provisions can help protect you if disputes arise.

✅ Use Payroll Providers With AB5 Modules

Don’t rely on spreadsheets and guesswork. Modern payroll systems with AB5 compliance tools help you track hours, breaks, and wage records, critical if the classification ever gets challenged in court.

✅ Budget For Payroll Tax Impact

Reclassification isn’t just a legal issue, it hits your bottom line. From workers’ comp premiums to Social Security contributions, the cost of shifting contractors to W-2 status must be planned for.

✅ Seek Legal Review

This isn’t the time for DIY risk management. Legal counsel can identify vulnerabilities you’ve missed, revise your policies, and help you build a classification system that holds up in court or under audit.

Misclassification is one of those problems you don’t realize you have until you’re already being sued. Taking these steps now can save you from years of backpay, penalties, and litigation. But if you’ve already received a demand letter or complaint, the time for prevention is over, it’s time to prepare for defense. Here’s what that litigation risk actually looks like.

Civil Lawsuits & PAGA Actions

When a worker believes they’ve been misclassified, they have more than one legal avenue to pursue, and none of them are cheap or simple for employers. Misclassification opens the door to a range of claims, from unpaid wages to broad-scale representative actions under the Private Attorneys General Act (PAGA).

The most common outcome is a wage and hour lawsuit, where the worker demands overtime, meal and rest break penalties, and reimbursement for business expenses. But under PAGA, a single employee can stand in the shoes of the state, suing on behalf of dozens or hundreds of others. These claims often escalate into class actions or mass arbitration demands, each carrying the potential for six- or seven-figure exposure.

Judges and juries are often sympathetic to workers, and California law stacks the deck in their favor. Even businesses that acted in good faith may find themselves paying statutory penalties and attorneys’ fees, on top of any back wages owed.

In short, misclassification doesn’t just create legal risk. It’s a magnet for litigation. If you want to avoid the courtroom, or at least walk in prepared, understanding the most frequently asked questions about California’s classification laws is the next step.

FAQs About Worker Classification In California

When it comes to classifying workers in California, confusion is common and costly. Below are some of the most frequent questions we hear from employers navigating the state’s tough compliance landscape.