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Understanding the difference between employees and independent contractors is essential to classifying your workers correctly.
Misclassifying workers as independent contractors when they’re employees—and vice versa—can result in large financial penalties and even potential criminal charges.
However, navigating the different and ever-changing independent contractor laws can feel daunting.
In this article, we provide an overview of independent contractor laws at the federal and state levels, including the common tests businesses must use to classify their workers.
This is a great starting point for understanding whether your workers are employees or independent contractors, what your obligations are, and where to find more information.
- Unlike employees, independent contractors have control over how they perform their work. They offer their services to the general public, whereas an employee typically works for a single employer.
- There are various tests to determine whether a worker is an employee or an independent contractor. Classifying workers correctly is essential to complying with your legal obligations and reducing the risk of penalties.
- Most federal agencies use a common law right of control or economic realities test. States sometimes adopt these tests, use their own common law tests, or apply the ABC test.
- The tests for independent contractors vary between federal and state agencies, and the law is complex. It’s a good idea to speak to an attorney to understand your obligations fully.
What Is an Independent Contractor?
Independent contractors are different from employees. Generally speaking, independent contractors perform services for the public, and businesses engage them for projects with defined end dates or parameters. For example, a publisher might contract a translator to translate a set number of books into another language.
Independent contractors have a high degree of control over their work and schedules. However, they do have to stick to the rules and expectations outlined in the contracts or service agreements they sign.
In addition, independent contractors can choose who they provide goods or services for. They’re also responsible for their own taxes and insurance.
Self-employed worker vs. independent contractor
People sometimes use the terms “self-employed worker” and “independent contractor” interchangeably. However, there’s an important distinction between them.
A self-employed worker doesn’t always work on a contract basis for clients. They might run their own business, like a store or restaurant, instead of or in addition to doing client work. They aren’t tied to a specific client, either.
So, while all independent contractors are self-employed, not all self-employed workers are independent contractors.
Why Is It Important To Classify Your Workers Correctly?
Worker classification affects labor law protections and tax obligations.
Labor laws typically offer more generous protections when there’s an employer-employee relationship. For example, the Fair Labor Standards Act (FLSA) covers employers—but not independent contractors—under its wage and hour provisions. While eligible employees are entitled to the minimum wage and overtime, independent contractors are not.
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Employees are usually entitled to a broader range of benefits, including leave, workers’ compensation, and unemployment benefits. For instance, the Family and Medical Leave Act (FMLA) applies only to employees, not independent contractors.
A worker’s classification also determines how they pay taxes. Employers are responsible for collecting and paying employees’ payroll taxes, including income, Medicare, and social security taxes. In comparison, independent contractors must manage and pay their own employment taxes.
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Employers must file 1009 tax forms for independent contractors and W-2 forms for employees. Learn more about these requirements and how to manage them in our article on the differences between 1099 and W-2 employees.
Employers who incorrectly categorize an employee as an independent contractor and vice versa expose themselves to financial penalties. In severe cases, they may also face criminal charges.
Worker Classification Laws
Figuring out if a worker is an independent contractor or an employee can be tricky because many different definitions and tests might apply. The appropriate test depends on your location. While there are several federal tests, individual states have their own distinct tests, too.
The relevant test also depends on your purpose for classifying the worker. For example, many states use different tests to determine whether a worker is an independent contractor for state tax, workers’ compensation, or unemployment insurance purposes.
Worker classification laws vary at the federal, state, and local levels and regularly change. For these reasons, you should seek legal advice from an employment law attorney to ensure you classify workers correctly.
Federal Independent Contractor Laws
Federal common law test
The Internal Revenue Service (IRS) and Social Security Administration (SSA) use this test for federal tax purposes. When you’re uncertain about how to classify a worker, you can apply to the IRS for a formal determination.
According to this test, a worker is an independent contractor if the hiring entity “has the right to control or direct only the result of the work and not what will be done and how it will be done.”
To figure this out, there’s a series of questions to consider:
- Behavioral control. Does the hiring entity have control over the worker and the work performed? This may include control over when and where the individual works.
- Financial control. Does the hirer control aspects of the worker’s business, including reimbursing expenses and providing tools and equipment?
- Relationship between the parties. Does the hirer provide the worker benefits like paid vacation or sick leave, pension plans, or insurance? Is there an ongoing professional relationship? Is the worker’s service a key part of the employer’s main business? For example, when a hotel hires a worker to install a new IT system, the worker is likely an independent contractor, as this falls outside the hotel’s main business.
When the answer to most of these questions is yes, it might mean the worker is an employee. However, no single factor or set of factors consistently determines whether a worker is an employee or independent contractor. Rather, the test looks at the working relationship as a whole to classify workers on a case-by-case basis.
Economic reality test
The Department of Labor (DOL) uses a different test to determine whether a worker is an employee under the FLSA. It asks whether the individual is dependent on the business for their economic reality. In other words, when an individual relies on a business to earn a living, they’re an employee rather than an independent contractor.
Currently, the core criteria for determining this are the nature and degree of control over work and the worker’s opportunity for profit or loss. The potential for profit or loss refers to a worker’s ability to make or risk their money through their business decisions. While independent contractors can grow their profits or risk losses based on their choices, employees typically receive set pay.
These core criteria are likely to change in October 2023 to include multiple additional factors, such as the permanency of the relationship.
State Independent Contractor Laws
Each state has its own independent contractor laws. Similar to the federal level, different state agencies use different tests. Some states adopt a federal test, others use state-specific common law tests, and some use the ABC test.
Different states use the ABC test for their own specific purposes (including workers’ compensation, minimum wage, unemployment insurance, and state tax purposes). Under this test, a worker is an employee unless they meet the following criteria:
- A: The hirer doesn’t control or direct the worker.
- B: The worker performs work outside the scope of the hirer’s usual business.
- C: The worker customarily engages in an independently established occupation, business, or trade. In other words, the worker has their own established business and they’re available and hired per job.
Some states use a variation of the ABC test, requiring consideration of only 2 of the 3 criteria or slightly modifying the requirements described above.
State independent contractor laws by state
|State||Independent contractor test|
|Colorado||A&C of ABC Test|
|District of Columbia||Common Law|
|Idaho||A&C of ABC Test|
|Montana||A&C of ABC Test|
|New Hampshire||ABC Test|
|New Jersey||ABC Test|
|New Mexico||ABC Test|
|New York||Common Law|
|North Carolina||Common Law|
|North Dakota||Common Law|
|Oklahoma||A&B or A&C of ABC Test|
|Pennsylvania||A&C of ABC Test|
|Puerto Rico||ABC Test|
|Rhode Island||ABC Test|
|South Carolina||Common Law|
|South Dakota||Common Law|
|Virginia||A&B or A&C of ABC Test|
|West Virginia||ABC Test|
|Wisconsin||A&C of ABC Test|
|Wyoming||A&C of ABC Test|
Example of independent contractor laws by state: California
The California Department of Industrial Relations uses the ABC test to determine if an individual is an independent contractor or employee for certain purposes, including workers’ compensation.
However, there are numerous exceptions to this for some occupations and industries, depending on the nature of their work. For example, certain licensed professions, including insurance agents, physicians, attorneys, and architects, use a common law test called the Borello test.
Different tests may also apply when considering unemployment insurance benefits, disability insurance, and state income taxes.
To find out which state independent contractor laws apply to your business, contact the key state government agencies responsible for employment or labor, workers’ compensation, unemployment insurance, and taxes.
Understanding each worker’s employment status is essential to complying with labor and tax laws. Worker misclassification puts your business at risk of significant financial penalties or, in serious cases, criminal liability. However, federal and state laws around worker classification are very complex. Different agencies use different independent contractor tests, and the rules change frequently.
While this article gives you an overview of independent contractor laws, it’s crucial that you seek advice from an employment law attorney about the laws that apply to you and the tests you should use. This approach ensures accurate classification and compliance.
Who controls the work of independent contractors?
Independent contractors control their work and how they do it. When assessing control, the IRS’s independent contractor test considers behavioral control, financial control, and the nature of the working relationship between the hirer and the worker.
What are the basics of an independent contractor agreement?
An independent contractor agreement outlines the terms of the arrangement between the hirer and the independent contractor. It addresses issues like scope of work, fees, and deadlines. It also usually states that the relationship is an independent contract rather than an employer-employee relationship.
The information presented on this website about independent contractor laws in the US is intended to be a summary for informational purposes only. However, laws and regulations regularly change and may vary depending on individual circumstances. While we have made every effort to ensure the information provided is up to date and reliable, we cannot guarantee its completeness, accuracy, or applicability to your specific situation. Therefore, we strongly recommend that readers seek guidance from their legal department or qualified attorneys to ensure compliance with applicable laws and regulations. Please note that we cannot be held liable for any actions taken or not taken based on the information presented on this website.