California AB5 — can I still use contractors for my dev agency or am I screwed?

I run a small dev agency in California. 2 W-2 employees and about 8 contractors - mostly senior devs who prefer the flexibility. They have their own LLCs, set their own hours, work with multiple clients.

Accountant just sent me a letter saying we need to "review worker classification" in light of AB5. She's worried some might need to be reclassified as employees.

These folks don't want to be employees. Several said they'd stop working with us if we tried to convert them. Is AB5 really that strict?

As one of those contractors who prefers 1099... please don't give up on the model. I have 4 agency clients right now. The flexibility is why I do this. If everyone converts to W-2 only I'd probably just leave California entirely.

Let me break this down because there's a lot of misunderstanding about AB5.

AB5 codified the "ABC test." Under this test a worker is presumed to be an employee unless you prove ALL THREE:

(A) Worker is free from control in performing work
(B) Work is outside your usual course of business
(C) Worker is engaged in an independently established business

For a dev agency hiring devs, part B is your problem. Dev work IS your usual course of business.

HOWEVER - AB5 has a "business-to-business" exemption. If your contractors meet certain criteria they get evaluated under the older, more flexible Borello test instead of ABC.

B2B exemption requires: contractor has their own business entity (LLC etc), own business location (can be home office), sets their own hours, negotiates their own rates, provides their own tools, maintains business license if required, has ability to work for multiple clients, written contract.

@EmilyM_Employment that's actually most of my contractors. They all have LLCs, work from home, set own hours, we negotiate rates, they use their own equipment, and most have 2-4 clients. Written contracts too.

What's the Borello test they'd be evaluated under instead?

Borello is a multi-factor balancing test - looks at control, specialized skill, investment in equipment, opportunity for profit/loss, payment method, length of relationship, whether parties believe it's employment. No single factor is determinative.

For senior devs with their own LLCs, multiple clients, specialized skills, set their own rates, and genuinely operate as independent businesses - they'd likely pass Borello.

Key is genuinely treating them as independent businesses, not just calling them contractors while treating them like employees.

Been through this exact thing. Run a design agency in LA with about 12 contractors. What we did:

1. Had employment lawyer review ($800 consultation)
2. Revised all contracts to better document the B2B relationship
3. Now require all contractors to have an LLC
4. Changed some relationships from hourly to project-based

Two of ours didn't actually meet the criteria (one worked exclusively for us). We converted those two to part-time W-2. Everyone else stayed 1099.

One more headache: even if you're AB5 compliant, IRS uses a different test and other states have their own rules. If you have contractors in Massachusetts their rules are even stricter than California's in some ways. Multi-state compliance is a whole other thing to discuss with a lawyer.

Update: took Emily's advice, had a consultation with an employment attorney ($450).

Good news: 6 of my 8 contractors clearly qualify for B2B exemption. Two are in gray area - they meet the criteria but their contracts don't document the relationship well. Revising those.

Money well spent for peace of mind. Thanks everyone.