Worker classification tests

Worker classification—determining whether someone is an employee or independent contractor—is one of the most consequential decisions in employment law. Get it wrong, and you face back taxes, penalties, wage claims, and legal fees. Get it right, and you maintain flexibility while staying compliant.

Multiple tests exist to determine classification, and they vary by jurisdiction and purpose. The IRS uses one framework for federal tax purposes. States use different tests for unemployment insurance and wage laws. Courts apply their own standards in litigation. Understanding these tests is essential for anyone working with contractors.

This guide provides a practical overview of the major classification tests. It's informational, not legal advice. When making classification decisions, consult qualified legal counsel familiar with your specific situation and jurisdictions.

The ABC test

The ABC test is used in many U.S. states for unemployment insurance and wage-hour law purposes. It's stricter than the IRS test and harder for workers to pass. Under the ABC test, a worker is presumed to be an employee unless the hiring entity proves all three conditions:

A. Free from 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 and in fact.

B. Outside usual business: The worker performs work that is outside the usual course of the hiring entity's business.

C. Independent trade: The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

All three conditions must be met. If any one fails, the worker is classified as an employee. This makes the ABC test particularly challenging for businesses whose contractors perform work that's central to the business (failing prong B) or who don't have an established independent business (failing prong C).

California's AB5 law famously uses the ABC test, making it difficult for many businesses to use contractors for core functions. Massachusetts, New Jersey, and other states also apply versions of the ABC test.

IRS common-law test

The IRS uses a common-law test for federal tax purposes, focusing on the degree of control and independence in the relationship. The IRS originally had a 20-factor test but has since simplified it into three main categories:

1. Behavioral control: Does the company control or have the right to control what the worker does and how the worker does their job? Factors include instructions about when, where, and how to work; training provided; and evaluation systems.

2. Financial control: Does the company control the business aspects of the worker's job? Factors include significant investment in equipment, unreimbursed expenses, opportunity for profit or loss, services available to the market, and method of payment.

3. Type of relationship: How do the parties perceive their relationship? Factors include written contracts, employee benefits, permanency of the relationship, and whether the services are a key aspect of the business.

No single factor is decisive. The IRS looks at the totality of the relationship. A worker might have some employee-like characteristics and some contractor-like characteristics. The question is which factors predominate.

The IRS test is generally more flexible than the ABC test, but it's also more subjective. There's no bright-line rule—just a facts-and-circumstances analysis.

Economic realities test

The U.S. Department of Labor uses the economic realities test to determine coverage under the Fair Labor Standards Act (FLSA). This test focuses on whether the worker is economically dependent on the employer or truly in business for themselves.

The economic realities test considers six factors: the nature and degree of control, the worker's opportunity for profit or loss, the worker's investment in facilities and equipment, the permanence of the relationship, the degree of skill required, and whether the work is an integral part of the employer's business.

Like the IRS test, no single factor is determinative. Courts weigh all factors together to assess the economic reality of the relationship. The test is designed to prevent employers from evading minimum wage and overtime requirements by misclassifying employees as contractors.

State-specific tests

Beyond federal tests, each state has its own classification standards for unemployment insurance, workers' compensation, and wage-hour law. Some states use the ABC test. Others use variations of the common-law test. Some have hybrid approaches.

California uses the ABC test for most purposes after AB5. New York uses a multi-factor test similar to the IRS common-law test. Texas uses a 20-factor test for unemployment insurance. Florida uses a different test for construction workers than for other industries.

This patchwork of state laws makes compliance challenging for businesses operating in multiple states. A worker might be properly classified as a contractor in one state but fail the test in another. You must comply with the laws of each state where your contractors work.

Practical factors that matter

Across all tests, certain factors consistently indicate contractor status. The worker controls when, where, and how they work. They use their own tools and equipment. They work for multiple clients simultaneously. They invoice for completed work rather than receiving regular paychecks. They carry their own insurance and handle their own taxes.

The worker has a clearly defined scope of work with specific deliverables. The relationship is project-based, not indefinite. The worker can hire subcontractors or assistants. They market their services to others. They have a business entity (LLC, corporation) and business infrastructure (website, business cards, separate business bank account).

Conversely, factors that suggest employee status include: the company sets the worker's schedule, provides training, supplies equipment, requires exclusive services, pays by the hour or week, provides benefits, integrates the worker into the business, and maintains the relationship indefinitely.

Documentation best practices

Proper documentation doesn't guarantee correct classification, but it helps demonstrate your intent and the nature of the relationship. Start with a written independent contractor agreement that clearly defines the scope of work, deliverables, payment terms, and the independent nature of the relationship.

Collect a W-9 form from U.S. contractors (or W-8BEN from international contractors) before starting work. Issue 1099-NEC forms annually for U.S. contractors paid $600 or more. Keep copies of invoices showing the contractor's business name, itemized services, and payment terms.

Document that the contractor uses their own equipment, sets their own schedule, works for other clients, and operates as an independent business. Keep records of the contractor's business entity formation, business insurance, and marketing materials.

But remember: documentation alone doesn't determine classification. If the actual working relationship looks like employment, no amount of paperwork will protect you. The substance of the relationship matters more than the form.

Common classification mistakes

The most common mistake is treating contractors like employees while calling them contractors. You set their schedule, require them to work from your office, provide equipment and training, prohibit them from working for competitors, and integrate them into your team—but call them contractors to avoid payroll taxes and benefits.

Another mistake is assuming that a written contract or the worker's agreement to contractor status is sufficient. Classification is determined by law, not by agreement. You can't contract around employment law. If the relationship meets the legal definition of employment, the worker is an employee regardless of what the contract says.

A third mistake is applying one test when multiple tests apply. You might satisfy the IRS test for federal tax purposes but fail your state's ABC test for unemployment insurance. You must comply with all applicable tests in all relevant jurisdictions.

When to get help

Classification is complex and high-stakes. If you're unsure about a worker's status, consult an employment attorney or tax professional familiar with your industry and jurisdictions. The cost of professional advice is far less than the cost of misclassification.

Consider getting help if: you're working with contractors who perform core business functions, you're operating in states with strict classification laws (California, Massachusetts, New Jersey), you're in a high-risk industry (construction, trucking, healthcare), or you're facing an audit or investigation.

You can also request a determination from the IRS using Form SS-8 or from your state unemployment agency. These determinations provide some protection if you follow them in good faith, though they're not binding on other agencies or in litigation.

The bottom line

Worker classification tests vary by jurisdiction and purpose, but they all focus on the degree of control and independence in the relationship. The ABC test is strictest, requiring that work be outside the usual course of business. The IRS common-law test is more flexible but more subjective. State tests vary widely.

Proper classification requires understanding the applicable tests, documenting the relationship carefully, and ensuring the actual working relationship matches contractor status. When in doubt, consult legal counsel. The cost of getting it right is far less than the cost of getting it wrong.

If you're working with true independent contractors—people who control their work, serve multiple clients, and operate independent businesses—contractor management software can help you maintain proper documentation and audit trails without the cost and complexity of an EOR.