What CFOs and legal teams need to know
AB5 codified the ABC test for California worker classification in 2020. Since Dynamex (2018), courts have applied the stricter three-prong standard to reclassify contractors as employees. AB2257 and Prop 22 created exemptions for specific industries and app-based platforms. For US companies hiring LatAm contractors from their home countries, AB5 generally does not apply territorially — but for California-headquartered companies with long-term full-time LatAm hires, EOR in the worker's country of residence is the safer risk-mitigation path. AB5-style rules are spreading beyond California, so the classification analysis matters even outside the state.
What AB5 is, in one paragraph
California Assembly Bill 5, signed into law in September 2019 and effective January 1, 2020, codified the ABC test that the California Supreme Court adopted in its landmark 2018 ruling Dynamex Operations West, Inc. v. Superior Court. Under the ABC test, a worker is presumed to be an employee unless the hiring entity proves three specific conditions. AB5 expanded application beyond the Wage Orders context of Dynamex to cover most provisions of the California Labor Code and the Unemployment Insurance Code. Subsequent legislation (AB2257 in 2020) added and refined industry-specific exemptions.
The ABC test, unpacked
All three prongs must be satisfied for a worker to be classified as a contractor:
- Prong A — 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 for performance and in fact. Written contract terms don't override actual practice.
- Prong B — Outside the usual course of business. The worker performs work that is outside the usual course of the hiring entity's business. A software company hiring a plumber for the office: passes prong B. A software company hiring a software engineer as a contractor: usually fails prong B.
- Prong C — Independently established trade. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed. Freelancers who have their own clientele, business cards, LLC, and marketing typically pass. Full-time workers whose only client is you rarely do.
Fail any one prong and the worker is an employee under California law for the purposes AB5 covers. Prong B is where most technology and marketing companies stumble when they classify long-term contractors doing core work.
The landmark cases shaping AB5
Dynamex Operations West, Inc. v. Superior Court
Delivery drivers for Dynamex, a same-day courier service, sued after being reclassified from employees to contractors in 2004. The California Supreme Court adopted the ABC test for determining employee status under the state's Wage Orders, replacing the prior multi-factor Borello test as the default for wage-and-hour purposes.
Vazquez v. Jan-Pro Franchising International, Inc.
Janitorial franchisees challenged their classification as independent contractors under Jan-Pro's three-tier franchise structure. The Ninth Circuit certified questions to the California Supreme Court, which held in 2021 that Dynamex applies retroactively. The Ninth Circuit later applied the ABC test on remand.
People v. Uber Technologies, Inc. / Uber v. Superior Court
The California Attorney General and city attorneys sued Uber and Lyft in May 2020, seeking to require reclassification of drivers as employees under AB5. Preliminary injunctions and appeals followed. The dispute became moot for app-based drivers with the passage of Proposition 22 in November 2020, which created a specific exemption for the category.
Castellanos v. State of California
Rideshare drivers challenged the constitutionality of Proposition 22 after voters approved it in 2020. The trial court initially found parts of Prop 22 unconstitutional; the Court of Appeal reversed. In July 2024, the California Supreme Court upheld Prop 22, confirming the exemption for app-based transportation and delivery drivers remains in effect.
Olson v. State of California
Uber, Postmates, and freelance workers challenged AB5 on equal protection grounds, arguing exemptions for certain industries but not app-based work were arbitrary. The Ninth Circuit remanded the equal protection claims for further proceedings; the litigation examined the constitutional limits on AB5's uneven industry treatment.
American Society of Journalists and Authors v. Bonta
Freelance journalists and photographers challenged AB5's original 35-item cap on freelance submissions to a single outlet on First Amendment grounds. AB2257 (2020) removed the numerical cap, mooting parts of the case. The Ninth Circuit upheld AB5's remaining provisions against the constitutional challenge.
Independent Truckers class actions
Independent owner-operator truck drivers challenged application of AB5 on federal preemption grounds under the Federal Aviation Administration Authorization Act (F4A). Courts have gone both ways, with the California Trucking Association case eventually reaching a resolution that limited federal preemption arguments. Reclassification exposure for trucking companies with owner-operator fleets remains significant.
Bowerman v. Field Asset Services
Field inspectors performing property preservation services for Field Asset Services were classified as contractors. The Ninth Circuit's analysis emphasized how integration into the hiring entity's core operations weighs heavily under prong B of the ABC test. Class certification issues also received substantial attention.
Instacart shopper misclassification actions
Local prosecutors pursued Instacart for allegedly misclassifying delivery shoppers before Prop 22 took effect. Settlements were reached in some jurisdictions, involving payments and prospective changes. Post-Prop 22, app-based delivery workers are covered by the exemption regime.
Cotter v. Lyft
An earlier era case addressing driver classification prior to AB5, illustrating the pre-Dynamex Borello test analysis. Settlement was reached but the litigation shaped subsequent analysis and the eventual push toward AB5 and Prop 22.
People v. GrubHub / DoorDash city attorney actions
Various local enforcement actions pressed app-based delivery platforms on classification before Prop 22 stabilized the category. Settlements and injunctive relief involved wage payments and process changes.
Employment Development Department audits
The California Employment Development Department regularly audits companies for unemployment insurance and payroll tax compliance under the ABC test. Non-litigation administrative actions are the most common enforcement vector and often precede or accompany private class actions.
SB 5 and follow-on legislative activity
Post-AB5 legislation (AB2257 in 2020 and subsequent bills) has repeatedly adjusted exemption categories, business-to-business relationship tests, and referral agency provisions. The statutory landscape continues to evolve.
Industry exemptions — where the ABC test does not automatically apply
AB5 and AB2257 exempt numerous categories from the ABC test, though exempted workers still must meet the older Borello multi-factor test to be classified as contractors. Broad categories include:
- Licensed professionals: lawyers, accountants, doctors, dentists, veterinarians, architects, engineers, private investigators.
- Real estate agents and repossession agencies.
- Direct sales: sales representatives compensated primarily on the value of sales.
- Freelance writers, photographers, editors, and content contributors, subject to specific conditions in AB2257.
- Marketing, graphic design, fine artists, grant writers, subject to per-industry criteria.
- Business-to-business relationships meeting a separate 12-factor test (bona fide business, own workspace, own tools, contract, independent operations, etc.).
- Referral agencies connecting clients to service providers under specified conditions.
Exemption is not automatic. The party asserting contractor status still bears the burden of meeting the applicable test. Getting the exemption category wrong is a common source of enforcement exposure.
What AB5 means for nearshore hiring
The threshold question: does AB5 apply territorially to a Mexican, Argentine, Colombian, Chilean or Peruvian contractor performing services from their home country for a US company?
Short answer: generally no. AB5 governs workers performing services in California. A LatAm resident performing services entirely from Mexico City, Buenos Aires, Bogotá, Santiago or Lima is outside California's territorial reach under most legal analyses.
Longer answer: it depends. Factors that pull LatAm contractors closer to AB5 exposure include:
- The contractor travels to California to work on-site for meaningful periods.
- The hiring entity is California-headquartered and the contractor is fully integrated into its California operations.
- The contractor is a US person or dual national with California ties.
- The services are consumed exclusively in California markets.
- Class action counsel adopts creative extraterritorial theories.
For California-headquartered companies with long-term full-time LatAm hires, the practical risk mitigation is straightforward: hire through an EOR in the worker's country of residence. The EOR structure:
- Eliminates the AB5 classification debate (the worker is an employee of the EOR, not a contractor of the US company).
- Aligns compliance with the worker's local labor law (LFT in Mexico, LCT in Argentina, CST in Colombia).
- Reduces Permanent Establishment risk in the worker's country.
- Provides the worker with local benefits, driving retention.
The trade-off is cost: 18-40% employer load plus 8-15% EOR fee vs zero employer load in contractor mode. For senior long-term hires, the risk mitigation typically justifies the load. For short output-based engagements with genuinely independent LatAm freelancers, contractor mode remains defensible on both AB5 and local grounds. Our decision framework guide walks through the trade-off in detail.
AB5 outside California
Several other US states have adopted or are considering ABC-test frameworks:
- Massachusetts: long-standing ABC test under Mass. Gen. Laws ch. 149, §148B, arguably as strict as California's.
- New Jersey: ABC test applied for unemployment insurance purposes, extended by case law to other contexts.
- Illinois: ABC test for construction industry and some other contexts.
- New York: intermittent legislative proposals to adopt ABC-style tests; current law relies on a multi-factor common law analysis with additional statutory rules for specific industries.
- Federal level: the US Department of Labor issued updated independent contractor classification regulations in 2024 based on a totality-of-the-circumstances economic reality test. Rulemaking activity continues into 2026 and companies operating multi-state should track federal developments alongside state law.
Companies hiring long-term contractors across multiple US states face a patchwork of classification standards. LatAm contractors performing services from LatAm are generally outside the direct reach of these state laws, but domestic contractors and dual-national workers may cross the classification line in unexpected ways.
Practical CFO checklist
- For any long-term contractor engagement, map the fact pattern against all three ABC prongs, plus the applicable industry exemption criteria if relevant.
- For California-headquartered companies with senior long-term LatAm hires, default to EOR in the worker's home country.
- Review contract templates annually to ensure they support (not undermine) contractor classification: clear scope, independent means of performance, no supervision language, no requirement to use company tools, no exclusivity.
- Audit actual practice against contract language. Prong A looks at both.
- Document the independent business existence of contractors (LLC, tax registration, marketing presence, multiple clients) to support prong C.
- For multi-state operations, layer state-by-state classification analysis on top of federal DOL guidance.
- Consult employment counsel in California and any other ABC-test state before scaling a contractor-heavy model.
Frequently asked questions
What is California AB5?
Assembly Bill 5, enacted 2019, effective January 1, 2020. It codified the ABC test for classifying workers as employees or contractors, established by the California Supreme Court in Dynamex (2018). AB5 presumes a worker is an employee unless the hiring entity proves three specific conditions.
What is the ABC test?
A worker is an employee unless the hiring entity proves: (A) freedom from control, (B) work outside the usual course of the hiring entity's business, and (C) engagement in an independently established trade. All three prongs must be met for contractor status.
Does AB5 apply to a LatAm contractor working from Mexico or Argentina?
AB5 governs services performed in California. A LatAm resident performing services remotely from their home country is generally outside AB5's territorial scope. For California-headquartered companies with long-term integrated LatAm contractors, EOR is the recommended risk-mitigation path.
What was Dynamex Operations West v. Superior Court?
The 2018 California Supreme Court case that adopted the ABC test for determining employee status under the state's Wage Orders. Delivery drivers sued after reclassification. The court replaced the prior Borello multi-factor test with the stricter ABC test.
What is Vazquez v. Jan-Pro Franchising?
A Ninth Circuit case that addressed retroactive application of the Dynamex ABC test. Janitorial franchisees challenged classification. The California Supreme Court held in 2021 that Dynamex applies retroactively.
What did Proposition 22 do?
Passed by California voters in November 2020, Prop 22 created an exemption from AB5 for app-based transportation and delivery drivers, subject to specific minimum earnings guarantees and benefits. The California Supreme Court upheld Prop 22 in 2024 in Castellanos v. State of California.
Which industries are exempt from AB5?
Broad exemption categories include licensed professionals, real estate agents, direct sales, freelance writers and creatives meeting specified criteria, marketing and design professionals, and business-to-business bona fide relationships meeting a separate 12-factor test.
What are the penalties for misclassification?
Unpaid wages, overtime, meal and rest break premiums, expense reimbursements, unemployment insurance and payroll tax liabilities, workers' compensation gaps. Willful misclassification carries civil penalties per California Labor Code §226.8 ranging from $5,000 to $25,000 per violation. Class action exposure is common.
Should California-based startups avoid LatAm contractors?
No. LatAm contractors performing services from home countries are generally outside AB5's territorial reach. For long-term full-time roles integrated into the California team, EOR through the worker's home country is the safer default.
Does AB5 create risk for other US states?
AB5 itself is California-only, but Massachusetts, New Jersey, Illinois and other states have ABC-test frameworks. Federal DOL classification rules add another layer. Multi-state operations should map exposure state by state and track federal rulemaking.