Worker Classification Tests: FAQ for Employers

Worker classification continues to be a hot topic as the independent workforce grows year over year. Workers generally fall into one of two groups: employees or independent contractors. Knowing the difference—and keeping up with new regulations—is essential for companies of all sizes and in any industry.

How do you determine the difference between independent contractors vs. employees?

An independent contractor is a legal term for someone who is not a W‑2 employee under the law. Independent contractors may call themselves freelancers, independent consultants, self‑employed professionals, or gig workers.

The key distinction: independent contractors operate as their own business entities. They:

• Pay their own taxes
• Provide their own benefits
• Invoice for completed work
• Decide how, when, and where their work gets done

In contrast, employees typically:

• Work under supervision
• Receive training from the company
• Follow employer‑set schedules and processes
• Receive wages, benefits, and job protections under labor laws

What is worker misclassification?

Worker misclassification occurs when a company incorrectly labels a worker as an independent contractor when they should legally be treated as an employee—or, less commonly, vice versa.

This distinction is important because employees and contractors have different rights, benefits, and tax obligations.

Worker misclassification can happen inadvertently or intentionally, but the consequences are the same:

• Loss of employee protections like minimum wage and overtime
• Back taxes, penalties, and interest owed by the hiring company
• Potential lawsuits and class actions
• Lower tax revenue for government agencies

The rules for worker classification vary across federal, state, and local laws—and have shifted again in 2025—making compliance a challenge.

See: 3 Benefits of Creating a Workforce Compliance Program

What are the federal worker classification rules?

The Department of Labor (DOL)

Worker classification under the Fair Labor Standards Act (FLSA) is determined using the economic reality test, which examines whether the worker is economically dependent on the employer (making them an employee) or is in business for themselves (making them an independent contractor).

• January 2021 rule — Focused on two core factors (control over work and opportunity for profit/loss) with three additional factors considered when needed.
• March 2024 rule — Expanded to a six‑factor totality‑of‑the‑circumstances approach, giving equal weight to all factors instead of emphasizing just two.
• May 2025 — The DOL announced it would pause enforcement of the 2024 rule, returning to earlier pre‑2021 guidance in investigations. This means the rule still exists, but DOL enforcement actions will use prior interpretations.

The six 2024 rule factors (still the law, even if not actively enforced by DOL) are:

1. Opportunity for profit or loss based on managerial skill
2. Investments by the worker and the employer
3. Degree of permanence in the relationship
4. Nature and degree of control
5. Whether the work is integral to the employer’s business
6. Skill and initiative

Note: Additional relevant factors may also be considered.

The IRS

The IRS has its own test based on three categories of evidence:

1. Behavioral control: Does the business direct how and when the work is done?
2. Financial control: Who provides tools, covers expenses, and carries the risk of profit or loss?
3. Relationship of the parties: Is there a contract? Are benefits provided? Is the arrangement ongoing or project‑based?

IRS determinations affect tax withholding, Social Security and Medicare contributions, and unemployment taxes.

Learn More: Benefits of Working With Independent Contractors Vs. Employees

Are there worker classification tests for specific states?

Currently, the majority of states have signed a Memorandum of Understanding with the Wage and Hour Division (WHD) to protect against misclassification. The MOUs affirm the intent to help provide easy access to employees and employers, share information, and coordinate misclassification investigation efforts.

Many states enforce stricter rules than federal law. Some—like California, New Jersey, and Massachusetts—use the ABC Test, which requires that a worker:

1. Be free from the employer’s control in performing their work,
   B. Perform work outside the usual course or location of the employer’s business, and
   C. Be customarily engaged in an independently established trade or business.

In 2025, several states have strengthened their worker classification standards and added related laws, such as pay transparency requirements, revised minimum wage rates, and expanded paid leave rules.

See: 10 Differences Between Independent Contractors and Employees

How does my company maintain workforce compliance?

With rules in flux, the best approach is to:

• Follow the strictest rules that apply to your location or industry
• Keep contracts and documentation for every engagement
• Use written agreements that clearly outline the independent nature of the relationship
• Periodically review classifications, especially before audits or large hiring initiatives

Bottom line: The distinction between employees and independent contractors is as important—and complicated—as ever. Laws and enforcement priorities are shifting, so companies should review their classification policies regularly to avoid compliance risks.