EDD Worker-Classification Audits Are Expanding in 2026: AB5, the ABC Test, and 8-Year Lookbacks
6 min read · By Tuan Phan, EA · June 2026
If your California business pays workers on 1099s, the Employment Development Department has become one of the most aggressive agencies you'll deal with. Heading into 2026, the EDD is intensifying its enforcement of Assembly Bill 5 — and because a single misclassification finding can ripple across state and federal agencies, a routine payroll audit can turn into a six-figure problem faster than most owners expect.
Why this is heating up now
AB5 codified the strict "ABC test" for worker classification, and for work performed on or after January 1, 2020, the EDD determines employment status using that standard. Several temporary industry accommodations that softened the early years of AB5 have been winding down, and the EDD has continued to expand payroll-tax compliance efforts. The result: more California businesses — especially in construction, trucking, staffing, and licensed service trades — are receiving audit notices.
The ABC test, in plain English
Under the ABC test, every worker is presumed to be an employee. To treat someone as an independent contractor, the hiring business must prove all three of the following:
- A — Freedom from control. The worker is free from your control and direction in performing the work, both under the contract and in practice.
- B — Outside your usual business. The worker performs work that is outside the usual course of your business. (This is the prong that catches most companies — a cleaning company hiring "contractor" cleaners, for example, almost always fails it.)
- 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.
Miss any one prong, and the worker is an employee for state payroll-tax purposes — no matter what your contract says.
How far back the EDD can reach
A standard EDD audit typically reviews about three years of records. But the lookback can extend further — up to eight years — when there are aggravating factors such as unfiled payroll returns, workers paid in cash, missing 1099 reporting, or other signs the agency believes wages went unreported. When documentation is weak, an audit that started as a routine review can quietly expand both its scope and its timeframe.
The multi-agency domino effect
The most underestimated risk is what happens after an EDD finding. The EDD shares data with the Franchise Tax Board and the IRS, so a state-level misclassification determination can trigger inquiries at the federal level and on your state income-tax side as well. One audit can become liability across multiple agencies — back payroll taxes (UI, ETT, SDI, and personal income tax withholding), plus penalties and interest, and potentially civil penalties for willful misclassification under California Labor Code section 226.8.
What to do if you use 1099 contractors
1. Run your own ABC-test review before the EDD does.
Go worker by worker. Pay special attention to prong B — anyone doing work that is part of your core business is the highest risk.
2. Tighten your documentation now.
Keep signed contracts, the contractor's business license and EIN, invoices, evidence they serve other clients, and proof they control their own schedule and tools. These are the records that win prongs A and C.
3. If an audit notice arrives, don't go it alone.
EDD auditors follow specific verification tests, and how you frame your relationships and present records early in the audit heavily influences the outcome. Get representation before you start handing over documents.
Facing an EDD audit or worker-classification notice? Free review.
If the EDD has contacted your business — or you're worried your 1099 contractors wouldn't survive the ABC test — send us your situation and we'll give you an honest assessment of your exposure and the best path forward.
Request Free EDD Review →About the author: Tuan Phan is an Enrolled Agent who represents California businesses in CDTFA sales tax and EDD payroll-tax audits and disputes. He practices at Tax Resolution Center LLC in San Jose, CA.