How do I handle employee vs subcontractor classification for my trades company?
California makes this harder than most states. Under AB 5 and the ABC test, every worker is presumed to be an employee unless you can prove all three of these conditions. If any one fails, the worker is an employee regardless of what your contract says or what the worker prefers.
Condition A is that the worker is free from your control and direction in how the work gets done. You can specify the outcome, but you can’t dictate hours, methods, tools, or processes. If you’re telling a plumber when to show up, what order to do tasks, and how to do them, that looks like employment.
Condition B is the hardest one for trades businesses. The worker must perform work outside the usual course of your business. An HVAC company hiring another HVAC technician as a 1099 fails this test because installing HVAC is exactly what the company does. This single condition disqualifies most of the subcontractor arrangements trades businesses try to set up.
Condition C requires the worker to have an independently established trade, occupation, or business of the same nature as the work performed. That means their own business license, their own insurance, their own clients beyond you, their own tools and vehicles, and evidence they hold themselves out to the public as an independent operator.
Construction has a narrow exception. Licensed contractors working for other licensed contractors under a written contract can be treated as independent under the Borello test rather than ABC, but only if specific conditions are met, including that the subcontractor holds their own state contractor’s license, carries workers’ comp for any employees, and maintains a business location separate from yours. This is why working with licensed subs matters in ways that go beyond just quality of work.
The penalties for getting this wrong are severe. You’ll owe back payroll taxes (both the employer and employee portions), unpaid workers’ comp premiums, unemployment insurance contributions, overtime and meal break violations, and civil penalties that can hit $5,000 to $25,000 per misclassified worker. The state actively investigates trades businesses because misclassification is so common in this industry. A disgruntled worker filing a claim with the EDD can trigger an audit that pulls in years of your payroll records.
Practically speaking, if a worker is regularly on your jobs doing your core trade work, they should be on payroll. Use 1099s for true specialists brought in for specific scopes, like a licensed electrician your plumbing company subs out for electrical portions of a bathroom remodel. Keep written contracts, verify their license and insurance, and document that they work for other businesses too.
As Pasadena bookkeepers who work with contractors and trades operators across the San Gabriel Valley, we see classification handled poorly more often than not. If you’re unsure about your current workers, get them reviewed before the EDD or IRS does it for you. Setting up clean payroll for workers who should be employees and proper 1099 processes for legitimate subs is straightforward. Fixing it after a state audit is not.
For businesses in the skilled trades, the cost of running legitimate payroll is almost always less than the exposure from misclassification. Workers’ comp, payroll taxes, and the administrative lift feel expensive until you compare them to a single misclassification finding that goes back three or four years.
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