California AB 5 and Workers' Comp: What Every Contractor Needs to Know

California Assembly Bill 5 (AB 5), signed into law in September 2019 and effective January 1, 2020, fundamentally changed how the state determines whether a worker is an employee or an independent contractor. For contractors — whether you're a general contractor, a specialty trade, or a sole proprietor who hires helpers — AB 5 has direct consequences for your workers' compensation obligations, your CSLB license standing, and your exposure to civil liability.

This article explains the ABC test that AB 5 codified, which contractor relationships it affects, the B2B exemption that many trade contractors rely on, and what happens when a worker is misclassified — including the workers' comp implications that most contractors don't realize until they receive a claim denial or an audit.

What Is AB 5 and the ABC Test?

Before AB 5, California used the Borello test — a multi-factor analysis — to determine worker classification. AB 5 replaced Borello with the ABC test for most workers, making it significantly harder to classify workers as independent contractors. Under the ABC test, a worker is presumed to be an employee unless the hiring entity can prove all three of the following:

• A — Free from control: The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract and in fact.
• B — Outside usual course of business: The worker performs work that is outside the usual course of the hiring entity's business.
• C — Customarily engaged in an independent trade: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

Prong B is the most consequential for contractors. If a general contractor hires a framing subcontractor, framing is arguably within the usual course of a general contractor's business — meaning the framer could be classified as an employee under AB 5, not an independent contractor.

The Business-to-Business (B2B) Exemption

AB 5 includes a business-to-business (B2B) exemption that is critical for most licensed subcontractors. Under this exemption, the ABC test does not apply when all of the following conditions are met:

• The subcontractor is a sole proprietor, partnership, LLC, or corporation
• The subcontractor is free from the control and direction of the contracting business
• The subcontractor is providing services directly to the contracting business, not to customers of the contracting business
• The subcontractor has a written contract specifying the payment amount and work to be performed
• The subcontractor is customarily engaged in an independently established business
• The subcontractor actually contracts with other businesses (not just one GC)
• The subcontractor maintains a business location separate from the contracting business
• The subcontractor has the required licenses and permits to perform the work
• The subcontractor can set their own hours and work for multiple clients
• The subcontractor is not performing work that is the same as the work performed by employees of the contracting business

For most licensed specialty subcontractors — electricians, plumbers, roofers, HVAC techs — the B2B exemption applies as long as they hold a valid CSLB license, have a written contract, and work for multiple clients. However, the exemption is not automatic: you must be able to demonstrate compliance with all conditions if audited.

AB 5 and Workers' Compensation: The Direct Connection

Workers' compensation in California is triggered by the employment relationship. If AB 5 reclassifies a worker you treated as a 1099 subcontractor as an employee, that worker is now entitled to workers' compensation coverage under your policy — retroactively.

This has several practical consequences:

• Claim exposure: If a worker you classified as a 1099 contractor is injured on the job and a court or the Workers' Compensation Appeals Board (WCAB) determines they were actually an employee under AB 5, your WC carrier may deny the claim — and you will be personally liable for all medical costs, lost wages, and permanent disability payments.
• Premium audits: Workers' comp premiums are calculated on payroll. If an audit reclassifies your 1099 subcontractors as employees, the auditor will add their payments to your payroll base and charge additional premium — often retroactively for the entire policy year.
• Uninsured employer penalties: If you have employees (including misclassified workers) and no WC policy, the California Labor Commissioner can assess penalties of up to $100,000 per employee per year and issue a stop-work order.

How AB 5 Interacts with SB-216

AB 5 and SB-216 operate on separate tracks but intersect in important ways for CSLB licensees. SB-216 (effective January 1, 2026) eliminated the sole-proprietor workers' compensation exemption for most CSLB license classifications. This means that even if you have no employees and qualify as a true sole proprietor, you must now carry an active WC policy (typically a ghost/owner-exclusion policy) to maintain your CSLB license.

AB 5 adds a second layer: if you hire workers — even occasionally — you must correctly classify them. If those workers are employees under the ABC test, they must be covered by your WC policy. The combination of AB 5 and SB-216 means that California contractors now face WC obligations from two directions: the licensing requirement (SB-216) and the employment classification requirement (AB 5).

Practical Steps for California Contractors

Given the combined effect of AB 5 and SB-216, here is what every California contractor should do to protect their license and limit liability:

• Verify your subcontractors are licensed. A licensed subcontractor who qualifies for the B2B exemption is not your employee. An unlicensed worker performing the same tasks almost certainly is. Always collect a copy of the sub's CSLB license and certificate of insurance before work begins.
• Use written subcontractor agreements. The B2B exemption requires a written contract. A verbal agreement does not satisfy the exemption. Your contract should specify the scope of work, payment terms, and confirm that the sub is an independent business.
• Carry your own WC policy. SB-216 requires it regardless of whether you have employees. A ghost policy (owner-exclusion policy) is the minimum required for a solo licensee. If you have employees, you need a policy that covers their payroll.
• Audit your 1099 relationships annually. If you regularly work with the same helpers or subcontractors, review the ABC test criteria each year. Relationships that started as B2B can drift into employment territory if the sub stops working for other clients or you begin directing their work.
• Consult a licensed CA insurance broker. Workers' comp classification and AB 5 compliance interact in ways that are not always intuitive. A broker who specializes in contractor insurance can help you structure your coverage correctly and avoid audit surprises.

Frequently Asked Questions

Does AB 5 apply to all contractors in California?

AB 5 applies to all businesses that hire workers in California, including contractors. However, the B2B exemption carves out most relationships between licensed contractors and licensed subcontractors, provided all exemption conditions are met. The ABC test is most likely to apply when you hire unlicensed workers or when a subcontractor works exclusively for you.

If my subcontractor has their own WC policy, am I protected?

Generally yes, if the sub qualifies as an independent contractor under the B2B exemption. If the sub is later reclassified as your employee, their own WC policy does not protect you — you would be the employer of record and liable for any uninsured claims. This is why verifying the B2B exemption conditions is essential, not just collecting a certificate of insurance.

Can I use a 1099 for a worker I hire regularly?

Issuing a 1099 does not determine employment status under California law. The ABC test applies regardless of how you pay or document the worker. A worker who receives a 1099 but fails the ABC test is still an employee for workers' compensation and labor law purposes. The IRS 1099 classification and California AB 5 classification are independent determinations.

What is the penalty for misclassifying an employee as an independent contractor?

Under California Labor Code §226.8, willful misclassification carries civil penalties of $5,000 to $25,000 per violation. In addition, the EDD can assess unpaid payroll taxes, the Labor Commissioner can issue a stop-work order, and if the misclassified worker is injured, you are liable for all workers' compensation costs as an uninsured employer — potentially $100,000+ per incident.

Does AB 5 affect my CSLB license directly?

AB 5 does not directly affect CSLB license status. However, if AB 5 reclassifies your workers as employees and you do not have a WC policy covering them, the resulting uninsured employer finding can trigger a CSLB license suspension under SB-216's active-policy requirement. The two laws interact: AB 5 determines who is an employee, and SB-216 requires that employees be covered by an active WC policy.

If you have questions about your workers' comp coverage in light of AB 5 and SB-216, contact Asena Capital at (858) 925-9555. We help California contractors structure their WC coverage correctly, verify subcontractor compliance, and avoid the audit surprises that come from misclassification.

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