Employee vs. Independent Contractor: IRS, DOL and State Tests

Contractors hire help in many ways: a helper for a week, a crew lead every day, a licensed sub for one phase of a job. Each arrangement raises the same question: employee or independent contractor? The answer decides who withholds taxes, who pays overtime, whether workers’ comp applies, and what penalties you could face for getting it wrong. This guide explains the main tests, current as of October 30, 2026. It is education only; an employment attorney or CPA can apply the tests to your situation.

Why does the label matter?

The IRS says it is critical that business owners correctly determine whether the people providing services are employees or independent contractors. For employees, you generally withhold and deposit income tax and Social Security and Medicare taxes, pay the employer share, and pay unemployment tax. For independent contractors, you generally don’t withhold or pay those taxes. Wage-and-hour rules (minimum wage and overtime) and, in most states, workers’ comp also follow employee status.

There isn’t one test. The IRS, the U.S. Department of Labor and your state can each apply a different standard, and a worker can be an employee under one and not another.

How does the IRS decide?

The IRS uses common-law rules and groups the evidence into three categories:

• Behavioral: does the company control, or have the right to control, what the worker does and how they do it?
• Financial: does the payer control the business side of the job, such as how the worker is paid, whether expenses are reimbursed, and who provides tools and supplies?
• Type of relationship: are there written contracts or employee-type benefits such as a pension plan, insurance or vacation pay, and will the relationship continue, with the work being a key aspect of the business?

No single factor decides it; the IRS looks at the whole relationship. If you can’t tell, either party can file Form SS-8 to ask the IRS for a determination.

What is the Department of Labor’s rule right now?

Under the federal Fair Labor Standards Act (FLSA), which covers minimum wage and overtime, the status of the federal rule is in transition. Here is what the Department of Labor’s own pages and the Federal Register show as of October 30, 2026:

• The 2024 rule is still on the books. DOL published a final rule on January 10, 2024, effective March 11, 2024, using a six-factor “economic reality” analysis. It is codified at 29 CFR Part 795.
• DOL isn’t applying it in its own investigations. DOL issued Field Assistance Bulletin 2025-1 on May 1, 2025, on independent contractor enforcement, and its 2026 rulemaking page describes the 2024 rule as one which it is no longer applying in its investigations.
• A replacement is only proposed. On February 26, 2026, DOL announced a proposed rule (91 FR 9932) to rescind the 2024 rule and adopt an economic-reality test built around two core factors: the worker’s control over the work, and the worker’s opportunity for profit or loss based on initiative or investment. Public comments closed April 28, 2026.
• No final rule yet. We found no final rule in the Federal Register as of October 30, 2026. Not verified: news reports about the rule’s review status; we’ll update this guide when a final rule is published.

In practice, courts in private lawsuits may still look at the 2024 rule and their own precedent. If your arrangement is close, get advice.

California: what is the ABC test?

California: for many state-law purposes, the California Labor and Workforce Development Agency explains that a worker is considered an employee unless the hiring business proves all three of these:

1. A: the worker is free from the business’s control and direction in performing the work, both under the contract and in fact;
2. B: the work is outside the usual course of the hiring business’s business; and
3. C: the worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work.

Prong B is where many contractors get caught. The state’s guidance says contracted workers in a role comparable to existing employees will likely be seen as working in the usual course of business, so a framing company that brings on “independent” framers is likely to have trouble with prong B. California’s guidance gives a contrasting example that does pass: a retail store hiring an outside plumber to fix a leak. California also lists exceptions, including certain individuals working under a subcontract in the construction industry, where the older Borello multi-factor test applies only after the hiring business meets other specific requirements. Read the state’s FAQ and get advice before relying on an exception.

What about other states?

Many states use their own tests for unemployment insurance, workers’ comp and wage law, and some are as strict as California’s. Florida, for example, has workers’ comp rules that can make an uninsured subcontractor’s workers count as the contractor’s employees; see our workers’ comp guide. Not verified: we haven’t reviewed every state’s test. Check your state labor department and unemployment insurance agency.

What paperwork goes with a real subcontractor?

• A written agreement describing the job, price and who supplies what.
• A Form W-9 before you pay, so you have the correct taxpayer ID.
• Their state contractor license number, if their trade requires one, and certificates of insurance.
• Form 1099-NEC when required. IRS Publication 15 notes the threshold rises from $600 to $2,000 for payments made in 2026 under P.L. 119-21.
• California: EDD says to report an independent contractor within 20 calendar days if you must file a 1099-NEC or 1099-MISC for them, you pay them $600 or more (or contract for $600 or more), and they are an individual, sole proprietor or single-member LLC.

What questions should you ask before you call someone a sub?

• Do they have their own business, license (if their trade requires one), insurance and other customers?
• Do they decide how, when and in what order to do the work, or do you?
• Do they bring their own tools and materials, set their price, and carry the risk of a loss on the job?
• Is the work part of what your company sells every day, or a separate specialty?
• Would the arrangement still look independent if a state auditor read your texts and schedules?

Mostly “no” answers point toward employee status. These questions are a starting point, not a legal test.

What if you got it wrong?

Misclassification can lead to back taxes, penalties, back wages and overtime, and uncovered injuries. If you think a worker should have been an employee, talk to a CPA or attorney about correcting it; the IRS lists a Voluntary Classification Settlement Program on its employee-or-contractor page for businesses that want to start treating workers as employees going forward. For setting up payroll the right way, see our first-employee guide.