Call Now (800) 681-1295
Close

How Does California’s AB 5 Affect My Business?

Table of Contents

    California’s Assembly Bill 5 (“AB 5”), effective January 1, 2020, and amended repeatedly since, grafted the Supreme Court’s Dynamex “ABC” test onto nearly every corner of state labor, payroll-tax, and workers’ compensation law. If your company relies on freelancers, gig workers, or owner-operators, AB 5 is not merely an HR wrinkle; it is a payroll-tax, wage-hour, unemployment-insurance, and workers’-comp minefield that can stretch three years back, pile on civil tax penalties, and in egregious cases, yield criminal-tax referrals.

    When it comes to California’s AB 5 worker-classification audits, the stakes could not be higher, and the window for effective intervention is dangerously narrow. The audit stage is where the battle is won or lost; appeals and Tax Court proceedings are often rubber-stamp reviews of whatever the examiner concluded. Because AB 5’s “ABC” test presumptively classifies most service providers as employees, EDD auditors walk in the door expecting payroll-tax non-compliance, back wages, and a cascade of penalties that can easily exceed the underlying tax. Add in FTB piggy-back assessments and the possibility of joint IRS examinations, and even a mid-sized misclassification case can threaten the very survival of a business. Proactive, strategic engagement at the audit level—supported by airtight documentation and a coherent legal narrative—is therefore paramount.

    At the Tax Law Offices of David W. Klasing, our dual-licensed Civil & Criminal Tax Defense Attorneys & CPAs monitor AB 5 audits from day one for any sign of badges of fraud—intentional misclassification, falsified 1099s, or double sets of books. The moment those badges appear, our mission pivots to damage control: keep the matter civil, avert any life-altering IRS-CI or FTB criminal-tax referral. We deploy attorney-client and Kovel privilege to quarantine sensitive communications, choreograph every document production, and, when strategically advantageous, negotiate closing agreements that exchange swift payment for sharply reduced Section 197 penalties and interest. Because appeals divisions and Tax Court judges overwhelmingly rubber-stamp the auditor’s findings, our entire strategy is engineered to win at the audit level—where the facts are formed and the narrative is set. By concentrating every resource on the audit’s critical inflection points, we resolve AB 5 disputes before they escalate out of control —protecting your livelihood, your reputation, and your net worth.

    The ABC Test—Presumption of Employment

    AB 5 codifies Dynamex and presumes every worker is an employee unless you can prove all of the following three prongs:

    • A – Autonomy – The worker is free from your control, in fact, and is under a written contract.
    • B – Outside the Usual Course – The work performed is outside the usual course of your business. (Prong B is the most challenging hurdle: a janitorial firm that sends “independent-contractor” janitors or a software house that hires freelance coders almost always fails here.)
    • C – Independently Established Trade – The worker is customarily engaged in an independent trade or business of the same nature and markets those services to others.

    Miss one prong, and the worker becomes a W-2 employee—entitled to minimum wage, overtime, paid sick leave, unemployment insurance, workers’ compensation, and the employer share of payroll taxes.

    For federal purposes, the IRS still applies its common-law factors of behavioral control, financial control, and the parties’ relationship. Consequently, a worker can be an independent contractor for the IRS but an employee for California—or vice-versa—forcing companies to juggle inconsistent withholding, reporting, and benefit rules. Many businesses reclassify across the board to minimize the administrative headache.

    AB 5 itself is prospective for EDD payroll-tax and workers’ compensation purposes. EDD may assess only for post-January 1, 2020, periods unless another statute has already applied the ABC standard. Wage-and-hour claims, however, can reach back because AB 5 declares the ABC test “declaratory” of existing law for Industrial Welfare Commission Wage Orders. If you qualify for one of the statutory exemptions, AB 5 expressly allows those safe harbors to be applied retroactively if they would relieve liability.

    Remember: Audit is the battleground. Our first objective is to marshal contracts, invoices, and third-party proof before the field examiner closes the case; overturns after that point are statistically rare. If an EDD auditor detects badges of fraud—cash payroll, missing Forms 1099, forged signatures—we immediately supply corrected filings, negotiate resolution, and keep the matter civil, attempting to avert any criminal-tax referral.

    If you receive an EDD or IRS notice announcing a worker classification or payroll-tax audit, the letter will spell out the deadlines, periods, and documents the examiner intends to review. At that moment, you should begin assembling every contractor agreement, payroll register, and Form 1099—and engage seasoned employment tax counsel. The Tax Law Offices of David W. Klasing pairs dual-licensed California Tax Attorneys & CPAs who know precisely how AB 5, the ABC test, and federal common-law factors collide in employment-tax examinations. We perform a privileged, line-by-line review of your contractor files and payroll data, surface any exposure before the government does, and craft a defensible narrative for the high-risk tax audit. Call 888-310-3543 or contact us online for a reduced-rate initial confidential consultation.

    How AB 5 Puts Your Whole Business Under a Microscope

    California’s ABC test is no longer just a local HR hassle—it is a flashing compliance beacon that can reach any company engaging even a single California-based freelancer. Below is what the leadership team of every business/company needs to know:

    Expect Intensified Scrutiny—No Matter Where You Are Headquartered

    AB 5 arms the EDD, IRS, Labor Commissioner, and disgruntled former contractors with a robust set of enforcement tools—expanding their ability to challenge worker classifications, pursue back taxes and penalties, and initiate litigation or audits with far greater ease. Whether you operate in Silicon Valley or Singapore, if your open-talent platform reaches workers who reside in California state and pay California income tax, the ABC test applies. That means your Slack-based design pool, your remote customer-success agents, or your one-off software consultant can trigger a California payroll-tax audit—even if your entity has zero physical presence in the state.

    Higher Cost of Misclassification—Payroll, Benefits, and Litigation

    A failed ABC test instantly transforms what was previously a flexible 1099 contractor payment into a full-fledged W-2 employee obligation—requiring the business to cover employer-side payroll taxes (FICA and FUTA), California unemployment and disability insurance (UI/SDI), workers’ compensation premiums, paid sick leave, overtime wages, and reimbursement for business-related expenses. Miss one worker and the EDD can demand three years of back payroll taxes plus interest and a 10 percent negligence penalty (15 percent for fraud). At the same time, the Labor Commissioner pursues unpaid wages, waiting-time penalties, and Private Attorneys General Act fines of $100–$200 per employee per pay period. Add uninsured-employer penalties of up to $100,000 and potential Trust-Fund Recovery Penalties against officers, and a single adverse audit can vaporize multi-year profits.

    Payroll tax crimes are aggressively prosecuted as trust-fund embezzlement, with the IRS & EDD treating unremitted withholdings as funds stolen from the U.S. Treasury. Employers are legally required to withhold Federal & California income tax, Social Security, and Medicare taxes—and remit them timely. Willful failures, such as underreporting wages on Forms 941, paying in cash to evade withholding, or using trust-fund taxes for operating expenses, are red flags for civil and criminal tax investigation. The IRS uses automated matching and audit triggers to identify discrepancies—such as returns showing withholdings but no deposits, erratic payroll dips, or historical delinquencies. Civilly, the Trust Fund Recovery Penalty (TFRP) imposes personal liability on responsible individuals for 100% of the unpaid taxes. Criminally, violators face up to five years in federal prison per count under 26 U.S.C. § 7202, fines up to $250,000 for individuals and $500,000 for corporations, restitution of all unpaid taxes, and reimbursement of prosecution costs.

    In high-profile payroll tax cases, courts have imposed severe criminal tax penalties following audits that uncovered trust-fund diversion and willful failure to remit withheld taxes. A Pittsburgh tax attorney was convicted on 16 counts for failing to pay over $790,000 in employment taxes; a Virginia contractor received 25 months in federal prison for misappropriating $700,000 in payroll withholdings; and a New York payroll processor was sentenced to eight years for misusing nearly $4 million in client trust-fund tax payments. These prosecutions underscore the catastrophic consequences of payroll audit findings escalating into criminal employment tax referrals.

    California’s Franchise Tax Board mirrors that aggressiveness: its 42-agent Criminal Investigation Division can prosecute even simple non-filers as misdemeanants and partners with IRS-CI in joint employment-tax cases. Once EDD flags unremitted withholding, the file can move straight to FTB agents unless experienced dual-licensed tax attorneys and CPAs shut that door first during the audit.

    Contractor Engagement Policies Must Be Re-Engineered

    Open-talent models remain viable, but they now require precision:

    • Create written B2B or professional-services agreements that memorialize worker autonomy, negotiated pricing, multiple-client warranties, and the contractor’s own business license.
    • Use objective, project-based deliverables rather than hours-based direction to satisfy Prong A.
    • Ensure contracted services are truly outside your core business—or restructure the work into an exempt referral agency or bonafide subcontract model to satisfy Prong B.
    • Require evidence the contractor actively markets to other clients to cement Prong C.

    A Timely Chance to Clean House Before the Government Knocks

    Many companies have not been tested on classification because no regulator came calling—until now. AB 5 is the wake-up call: conduct a privileged workforce audit, correct exposures, and document exemptions before an EDD auditor arrives. Doing so now protects margins later and demonstrates good-faith compliance if scrutiny follows.

    Bottom Line: AB 5 raises the stakes for every enterprise that taps independent talent. Treat the statute as an opportunity to refine your contractor strategy, shore up documentation, and insulate both profits and personal liability from the inevitable wave of California enforcement. The Tax Law Offices of David W. Klasing stands ready to guide that process—privileged, precise, and proactive.

    Our firm blends deep tax-law expertise with strategic defense, giving business owners a single, coordinated team that can confront an AB-5 payroll-tax audit one day and orchestrate a voluntary disclosure the next. When an EDD or IRS high-risk audit alleges willful misclassification—cash payroll, falsified Forms 941, diverted trust-fund taxes—we launch an immediate damage-control mission: challenge every factual assertion, supply corrected filings under privilege, narrow the examiner’s scope, negotiate repayment terms, and keep the matter strictly civil, shutting down any referral to IRS-CI or FTB criminal tax Investigation. This audit-stage strategy preserves enterprise cash flow, shields management’s personal assets, and safeguards the brand you worked so hard to build.

    Who Can Still Get a 1099?—Exemptions Without a Free Pass

    The Legislature has carved out more than fifty exemptions, but each exemption merely returns you to the older Borello right-of-control analysis; none is a blank check. Examples include:

    • Licensed professionals—lawyers, CPAs, doctors, dentists, architects, engineers—so long as they invoice under their name, set their own rates and maintain an independent office.
    • Business-to-business contractors—only if the contractor provides services to the hiring company and maintains a separate clientele, advertises to the public, negotiates price, supplies its own tools, and bears an entrepreneurial risk.
    • “Professional services” creatives—graphic designers, grant writers, fine artists, photographers, freelance writers, editors, and newspaper cartoonists, subject to strict conditions (e.g., no more than 35 content submissions per client per year unless they otherwise meet a B2B model).
    • Referral-agency relationships—applies only to narrow household and personal-service categories such as tutoring, home cleaning, minor repairs, dog walking, pool cleaning, and yard work; the service provider must serve multiple clients and hold itself out as independent.
    • Construction subcontracts—CSLB-licensed subs that control their labor, price, and tools and carry their own insurance.

    Because the statutory language is exacting, businesses that miss a single element fall back into full ABC scrutiny.

    Contact the Tax Law Offices of David W. Klasing—Your One-Stop AB 5 Defense & Compliance Partner

    At the tax law offices of David W. Klasing, our dual-licensed Civil & Criminal Tax Defense Attorneys & CPAs audit your workforce under attorney-client and work-product privilege, map every role against the ABC test and Borello exemptions, and build a practical reclassification blueprint: compliant contracts, B2B entity structuring, multi-client independence, payroll-tax budgeting, and annual re-testing as the law evolves. When a high-risk EDD or IRS worker-classification audit is already under way, we triage the examiner’s requests, align each worker with the ABC factors, and assemble the evidence that must win at the field-audit level—because EDD Appeals and California tax courts are statistically rubber stamps of the auditor’s report. Where the auditor spots badges of fraud—cash payroll, missing 1099s, falsified Forms 941—we launch a damage-control mission: supply corrective filings, negotiate restitution, cap civil tax penalties, and keep the matter strictly civil, blocking any IRS-CI or FTB Criminal Investigation referral.

    Early-stage engagement means you correct voluntarily, not under subpoena, and keep the matter safely on the civil track without exposing yourself to a life-altering criminal tax prosecution. David W. Klasing is one of fewer than an estimated 3,000 professionals nationwide who hold both attorney and CPA licenses and has earned a Master’s in Taxation. Our single, transparent hourly rate covers legal strategy and accounting analysis; our appointment-only satellite offices put us statewide; and David—an instrument-rated pilot—flies to your location without billing travel time or expenses. An A+ BBB rating and perfect 10.0 AVVO score attest to an unbroken record of audit defenses and penalty abatements.

    Do not wait for tax courts and appeals. Win at the audit stage. Call 800-681-1295 or use our encrypted scheduler for a reduced-rate AB 5 compliance initial consultation. We will privilege-shield your contractor review, craft an enforceable labor model, and keep California state’s most aggressive employment and tax enforcement regime from swallowing your profits—or your personal assets.

    Tax Help Videos

    Representing Clients from U.S. and International Locations Regarding Federal and California Tax Issues

    tax lawyers

    Main Office

    Orange County
    2601 Main St. Penthouse Suite
    Irvine, CA 92614
    (949) 681-3502

    Our headquarters is located in Irvine, CA. Our beautiful 19,700 office space is staffed full-time and always available for our clients to meet with our highly qualified and experienced staff of Attorneys, Certified Public Accountants and Enrolled Agents. We also offer virtual consultations and can travel to meet with clients in one of our satellite offices.

    Outside of our 4 hour initial consultation option, we do not charge travel time or travel expenses when traveling to one of our Satellite offices, or surrounding business districts, where it is necessary to meet personally with taxing authority personnel, make court appearances, or any in person meeting deemed necessary for the effective representation of a client. To make this as flexible, efficient, and convenient as possible, David W. Klasing is an Instrument Rated Private Pilot and Utilizes the Firms Cirrus SR22 to service client’s in California and in the Southwest by air. Offices outside these areas are serviced via commercial jet airlines. None of these costs are charged to our clients.

    Satellite Offices

    California
    (310) 492-5583
    (760) 338-7035
    (916) 290-6625
    (415) 287-6568
    (909) 991-7557
    (619) 780-2538
    (661) 432-1480
    (818) 935-6098
    (805) 200-4053
    (510) 764-1020
    (408) 643-0573
    (760) 338-7035
    Arizona
    (602) 975-0296
    New Mexico
    (505) 206-5308
    New York
    (332) 224-8515
    Texas
    (512) 828-6646
    Washington, DC
    (202) 918-9329
    Nevada
    (702) 997-6465
    Florida
    (786) 999-8406
    Utah
    (385) 501-5934