California ABC Test in an EDD Audit: A, B and C Explained

By Marc Boulanger, CPA

If your California business paid workers as independent contractors, the ABC test may become one of the most important issues in an EDD employment tax audit.

When the ABC test applies, California generally presumes that an individual providing labor or services for compensation is an employee. The hiring business must establish all three parts of the test before the worker can be treated as an independent contractor under that standard.

Those three requirements are commonly called Part A, Part B, and Part C.

Why Does the ABC Test Matter in an EDD Audit?

One of the issues an EDD employment tax auditor may examine is whether workers were properly classified.

The business may have issued Forms 1099, obtained written independent contractor agreements, or treated the workers as contractors in its accounting records.

None of those facts, by themselves, determines employment status.

The auditor must consider the classification standard that legally applies to the particular worker and relationship.

For many workers, that analysis begins with the ABC test.

The Starting Point: The Worker Is Presumed to Be an Employee

This is an important feature of the ABC test.

When the test applies, the starting point is not that a worker is an independent contractor because the parties called the person a contractor.

EDD's published guidance states that an individual providing labor or services for compensation is presumed to be an employee unless the hiring entity demonstrates all three conditions of the ABC test.

That makes the underlying facts of the working relationship particularly important during an audit.

Part A: Is the Worker Free From Control and Direction?

Part A examines whether the worker is free from the control and direction of the hiring entity in connection with performing the work.

Importantly, EDD's guidance describes this as freedom from control and direction both under the contract and in actual practice.

In an audit, relevant questions may include:

• Who determines how the work is performed?
• Does the business supervise the worker?
• Does the business control the worker's schedule?
• Does the business provide instructions about how services must be performed?
• Does the worker operate independently in performing the service?
• What does the written agreement say about control?
• Does the actual working relationship match the agreement?

A contract describing someone as an independent contractor does not end the analysis. The actual relationship matters.

Part B: Is the Work Outside the Usual Course of the Business?

Part B asks whether the individual performs work outside the usual course of the hiring entity's business.

This can become a major issue when a business uses contractors to perform the same type of service that the business itself provides to customers.

Consider the basic question:

The answer depends on the actual business and the work performed. A particular occupation should not automatically be classified one way or the other without analyzing the facts and determining whether the ABC test applies.

Why the Company's Actual Business Matters

The same type of worker can raise a different Part B question depending on who hires that worker.

For example, services that are unrelated to one company's normal business may be central to another company's operations.

That is why I want to understand what the audited business actually does before analyzing Part B.

Part C: Does the Worker Have an Independently Established Business?

Part C asks whether the individual is customarily engaged in an independently established trade, occupation, or business of the same nature as the work being performed.

This focuses attention on whether the worker is actually operating an independent business rather than simply being labeled a contractor by the hiring company.

Depending on the circumstances, relevant facts may include:

• Whether the worker has an independently established business
• Whether the worker offers similar services to others
• Whether the worker has other customers
• Whether the worker maintains business operations separate from the hiring entity
• Whether the worker advertises or otherwise makes services available to the market
• Whether licenses or business registrations relevant to the work exist
• Whether the worker bears ordinary expenses associated with an independent business

No single item on that list should be treated as a substitute for applying the legal standard to the complete facts.

Does Passing Two Out of Three Parts Work?

No, not when the ABC test applies.

The hiring entity must establish A, B, and C.

Does Issuing a 1099 Satisfy the ABC Test?

No.

Form 1099 is an information-reporting document. It does not determine whether a worker satisfies Parts A, B, and C.

Likewise, simply paying a worker without withholding payroll taxes does not make the worker an independent contractor.

For a broader discussion of how EDD examines these workers, see our EDD Independent Contractor Audit Guide.

Does an Independent Contractor Agreement Satisfy the ABC Test?

Not by itself.

A written agreement can be relevant evidence, particularly when examining the parties' rights and responsibilities. But the actual working relationship remains important.

During an EDD audit, I want to compare what the contract says with what actually occurred.

Does the ABC Test Apply to Every California Worker?

No. This is an important limitation.

California law contains statutory exclusions and exceptions. EDD states that in some situations the Borello multifactor test must be used instead of the ABC test. Other classification standards can also apply to particular relationships.

What Is the Borello Test?

The Borello test is a multifactor worker-classification standard that continues to apply in certain circumstances where California law provides an exception from the ABC test.

It is therefore possible for two workers performing different types of services for the same company to be subject to different classification analyses.

The applicable exception and its requirements should be reviewed before deciding which test controls.

How Does the ABC Test Come Up During an EDD Audit?

The issue often begins with the accounting records.

An auditor may identify payments to individuals through Forms 1099, the general ledger, bank and check records, invoices, or contractor accounts.

The next question is whether those payments were made to true independent contractors or should have been treated as employee wages.

EDD may request written agreements, invoices, billings, and other information concerning the working relationship.

See: What Records Does an EDD Auditor Request?

What I Look at First in an ABC Test Audit

When an EDD audit involves independent contractors, I do not begin by assuming every worker is subject to exactly the same analysis.

I generally want to identify:

• What services each worker actually performed
• What the audited company actually does
• Whether the ABC test applies to that particular relationship
• Whether an exception or another classification standard applies
• What the written agreements say
• How the relationship operated in practice
• How the worker was paid
• Whether the worker operated a separate business
• Whether similar workers were treated consistently
• What evidence exists to support the classification

Only after identifying the correct legal framework does it make sense to work through the classification analysis.

What if the Same Person Received Both a W-2 and 1099?

That creates another layer of analysis.

A person can potentially have separate working relationships with the same business, but simply issuing two different tax forms does not establish that the contractor portion was properly classified.

The services and applicable classification rules need to be examined separately.

See our detailed guide: Can You Be a W-2 Employee and 1099 Contractor for the Same Company in California?

What Happens if EDD Determines the Workers Were Employees?

If EDD concludes that workers treated as independent contractors should have been treated as employees, payments to those workers may become part of an employment tax assessment.

Depending on the circumstances, the resulting liability may include employment taxes, interest, and applicable penalties.

The amount can become more significant when the classification practice affected multiple workers or multiple quarters.

Can You Dispute an EDD Worker-Classification Finding?

Yes. An employer can dispute audit findings when it disagrees with the Department's classification analysis or resulting calculation.

The dispute may involve questions such as whether the correct classification test was applied, whether an exception applies, whether the facts support the Department's conclusion, which workers and payments should be included, and whether the resulting assessment was calculated correctly.

For more information about the broader process, see EDD Audit Appeals.

California EDD ABC Test FAQs

What is the California ABC test?

The ABC test is a worker-classification standard used in California. When it applies, a worker providing services for compensation is presumed to be an employee unless the hiring entity establishes all three conditions of the test.

What are Parts A, B and C of the ABC test?

Part A concerns freedom from control and direction. Part B concerns whether the work is outside the usual course of the hiring entity's business. Part C concerns whether the worker is customarily engaged in an independently established business of the same nature as the work performed.

Do you have to pass all three parts of the ABC test?

Yes, when the ABC test applies. The hiring entity must establish all three conditions.

Does issuing a 1099 make someone an independent contractor?

No. Issuing Form 1099 does not determine employment status. The applicable California worker-classification rules and the facts of the working relationship determine whether the worker qualifies as an independent contractor.

Does the ABC test apply to every worker in California?

No. California law contains exclusions and exceptions. Depending on the particular worker and relationship, the Borello multifactor test or another classification standard may apply instead.

Can EDD use the ABC test during a payroll tax audit?

Yes. Worker classification is an issue EDD may examine during an employment tax audit, and the ABC test is used when it is the classification standard applicable to the worker and relationship being examined.