You Call Them Contractors. California Calls Them Employees. The Difference Is About $40K

The agency is growing. You landed two new retainers this spring, so you added a designer and a copywriter the way most studios do: a 1099, a Slack invite, and a standing Monday check-in. Eighteen months later, the designer moves on and files for unemployment. A few weeks after that, the EDD sends a letter asking why someone who worked your hours, on your clients, in your tools, was never on payroll.

That letter is how many agency owners learn that California does not care what you called the relationship. It cares how the relationship actually worked.

Why creative agencies are squarely in the crosshairs

The state uses the ABC test, and all three parts have to pass. We cover each prong in detail in our California AB 5 and ABC Test guide. For agencies, one prong causes most of the damage.

Prong B asks whether the work falls outside the usual course of your business. For a creative or marketing agency, design, copywriting, social content, video, and web builds are not outside the usual course of business.

They are the business.

A designer producing client deliverables is doing what your agency sells, which is why creative roles rarely pass the ABC test at an agency.

The creative exemptions are narrower than they sound

This is usually where agency owners push back: "Didn't California exempt designers and writers?"

Partly. After AB 5, the Legislature added a professional services exemption that covers, among others, original and creative marketing work, graphic design, fine art, still photography and videography, and freelance writing, editing, and illustration. Cal. Lab. Code § 2778

The exemption comes with conditions, and every one has to be met. Among them, the individual:

• Keeps a business location separate from yours. Their home can count.
• Holds a business license where one is required.
• Can set or negotiate their own rates.
• Sets their own hours, outside of reasonable project deadlines.
• Works for other clients, or holds themselves out to the public as available to.
• Regularly uses their own discretion and independent judgment in the work.

Photographers, videographers, writers, and editors carry added requirements, such as a written contract that states the rate and when payment is due, and not directly replacing an employee who did the same work.

What if you hire their LLC instead? California has a separate business-to-business exemption with its own list of requirements. Cal. Lab. Code § 2776 One of them generally looks at whether the provider serves your agency directly rather than your clients. For agencies that pass white-label work straight to clients, that condition deserves a careful look before you rely on it.

Where the $40K comes from

Here is a simplified, illustrative example. One designer, paid $65,000 a year on a 1099 for two years, working about 44 hours a week. Then the relationship is reclassified.

It does not include interest. It does not include civil penalties of $5,000 to $15,000 per violation when misclassification is found willful. Cal. Lab. Code § 226.8 And it does not include attorneys' fees, which California wage law often shifts to the employer when the worker prevails.

Now picture three people on the same arrangement. Under the Private Attorneys General Act, one worker can pursue penalties on behalf of everyone else in the same situation.

If you are the freelancer

This applies to you in two ways.

Red flags agencies tend to miss

• Your contractor is expected online during your business hours and joins your internal standups.
• They use an agency email address and introduce themselves to clients as part of your team.
• You pay a fixed monthly amount regardless of what gets delivered.
• You trained them on your internal process and review their work the same way you review staff.
• They replaced a W-2 employee who used to do the same job.
• You have been their only meaningful client for a year or more.

Build it in before the next hire

1. List everyone you have paid on a 1099 in the last three years, with their role and how long they have worked with you.
2. For each creative role, check the § 2778 conditions in writing and keep proof: the business license, the portfolio site, evidence of other clients.
3. Update your independent contractor agreement so it matches reality: deliverables-based scope, rates the contractor sets or negotiates, their own tools, no exclusivity, and a clear intellectual property assignment so your agency owns the work it sells. Our contract services cover this.
4. Stop managing contractors like staff. Project deadlines are fine. Required hours and internal meetings are not.
5. When a role is core and ongoing, move it to payroll and build the cost into your pricing. Growing agencies weighing that cost against their entity structure may find our S-Corp vs. LLC in California breakdown useful.
6. Have the classification review done through counsel. An attorney-led review is generally privileged. A self-audit you write down can become evidence against you. A Business Check Up is a practical place to start.

The bottom line

Growing on 1099s feels lean and flexible, and for a while it usually is. Then someone leaves, files a claim, and the state asks the question you never answered: how did this relationship actually work?

Answer it now, while you choose the structure, rather than later, when an auditor chooses it for you.

The information in this document is for information and educational purposes only and does not establish an attorney-client relationship, nor is it intended to be legal advice. You should contact an attorney for advice regarding your individual situation.