A worker is your employee if you control what they do and how they do it; they are an independent contractor if they run their own business and decide how the work gets done. The IRS looks at behavioral control, financial control, and the type of relationship, and no single factor decides it. A signed contractor agreement or a 1099 does not settle the question. The Department of Labor and your state apply their own tests, which can be stricter, so the same worker can be a contractor for federal tax and an employee under state law.
What does the IRS look at?
The IRS weighs three categories of evidence across the whole relationship, with "no 'magic' or set number of factors".
| Category | Points toward employee | Points toward contractor |
|---|---|---|
| Behavioral control | You set hours, give instructions, train them, and review how the work is done | They decide how, when, and where to do the work; you judge only the result |
| Financial control | Hourly or salary pay, you supply tools and reimburse expenses | They invoice per job, buy their own equipment, can make or lose money on the work |
| Type of relationship | Ongoing, open-ended work that is a core part of your business; benefits | A defined project, work outside your main business, no benefits |
If you tell the person when to show up, hand them your equipment, and they do what your business sells, you are describing an employee. This test governs federal employment taxes only; minimum wage, overtime, and state unemployment have their own tests.
Does the Department of Labor use the same test?
No. For minimum wage and overtime under the Fair Labor Standards Act, the DOL uses an "economic reality" test: is the worker in business for themselves, or economically dependent on yours? As of September 19, 2026, the details are in flux:
- The DOL's 2024 six-factor rule is still on the books and applies in private lawsuits, but since May 2025 DOL investigators use its 2008 guidance instead.
- In February 2026, the DOL proposed a replacement that weighs two factors most heavily: control over the work, and the worker's opportunity for profit or loss. Comments closed April 28, 2026, and no final rule has been issued.
The DOL's employment-relationship fact sheet says signing an independent contractor agreement "does not make a worker an independent contractor", and neither does where the work happens or how the worker is paid.
What is the ABC test, and does my state use it?
Many states use an ABC test for unemployment insurance and state wage laws. It presumes the worker is an employee, and you must prove all three prongs to treat them as a contractor:
- A: The worker is free from your control and direction in doing the work.
- B: The work is outside the usual course of your business.
- C: The worker is customarily engaged in an independently established trade or business of the same kind.
A café cannot pass prong B for a barista, because making coffee is its usual business. The details vary by state:
- California uses the ABC test under Labor Code sections 2775 to 2787, with exemptions for some professional services, licensed professionals, and business-to-business arrangements that meet a list of conditions. Willful misclassification carries a civil penalty of $5,000 to $15,000 per violation, or $10,000 to $25,000 for a pattern or practice.
- Massachusetts requires the work to be outside the usual course of the business, with no other way to pass prong B.
- New Jersey also lets you pass prong B if the work is done outside all of your places of business. New ABC test regulations take effect October 1, 2026.
Find your state's test through the DOL state labor office directory.
What paperwork does each one need?
Employees go on payroll; contractors fill out a W-9 and may get a 1099-NEC.
| Employee | Independent contractor | |
|---|---|---|
| Collect at hire | Form W-4, Form I-9, state new-hire report | Form W-9 (name and taxpayer ID) |
| Withhold each payday | Federal income tax, Social Security, Medicare (Pub 15) | Nothing, unless backup withholding at 24% applies because they gave no correct TIN |
| You pay | Employer share of FICA, FUTA, state unemployment | Nothing beyond the invoice |
| Year-end form | W-2, plus quarterly Form 941 | 1099-NEC if you paid them $2,000 or more |
For payments made in 2026, the 1099-NEC threshold is $2,000, up from $600, though you file at any amount if you backup-withheld and some states have their own contractor reporting rules. The W-2 and the 1099-NEC are both due to the worker, and to the SSA (W-2) or IRS (1099-NEC), by January 31, moved to the next business day on a weekend, so February 1, 2027 for 2026 pay. Staying under $2,000 skips the form, not the classification question.
What happens if I get it wrong?
You owe the payroll taxes you should have paid, at reduced rates if the mistake was not intentional, plus interest and penalties. The IRS charges you the employer share in full and, under IRC section 3509, a fraction of the employee side:
- The employer share of FICA in full: 7.65% of wages (Pub 15)
- 1.5% of wages in place of the income tax you did not withhold
- 20% of the employee's share of FICA
That adds up to 10.68% of wages up to the 2026 Social Security wage base of $184,500. If you also failed to file 1099s, the rates double to 3% and 40%, for 13.71%. If the IRS finds intentional disregard, you owe the full amounts.
On top of that come late deposit penalties of 2% to 15%, per-form penalties for unfiled W-2s, overtime and minimum-wage back pay, state unemployment tax, and workers' comp exposure. The worker can also raise it with the IRS by filing Form 8919 to pay only the employee share of Social Security and Medicare.
What does that look like in dollars?
Take a café owner who paid a barista $30,000 in 2026 as a contractor. The barista works shifts the owner schedules, on the café's equipment, making the café's menu. That fails the IRS control test and prong B of every ABC test.
If the café filed a 1099-NEC (section 3509(a)):
| Item | Rate | Amount |
|---|---|---|
| Income tax in place of withholding | 1.5% × $30,000 | $450 |
| Employee FICA | 20% × 7.65% = 1.53% × $30,000 | $459 |
| Employer FICA | 7.65% × $30,000 | $2,295 |
| Subtotal | 10.68% × $30,000 | $3,204 |
| FUTA (if the full state credit applies) | 0.6% × $7,000 | $42 |
| Total before interest and penalties | $3,246 |
If the café filed no 1099: income tax becomes $900 (3%), employee FICA becomes $918 (3.06%), and employer FICA stays $2,295, for $4,113. With FUTA, that is $4,155, before interest, penalties, and state unemployment tax.
If the café files the 2026 1099-NEC, then applies to the settlement program below in 2027: the payment is based on the last completed year, so it pays 10% of $3,204, or $320.40, with no interest or penalties, and moves the barista to payroll.
The "savings" the owner was chasing was the $2,295 in employer FICA plus FUTA and state unemployment: the employer-side cost of an employee, which misclassifying does not remove.
Can I fix a past mistake?
Yes. The IRS Voluntary Classification Settlement Program (VCSP) lets you move workers to payroll by paying 10% of one year's reduced-rate liability, with no interest or penalties and no audit of prior years on those workers' classification. You must have consistently treated the workers as contractors, filed all required 1099s for them for the previous three years, and not be under an IRS employment tax audit or a DOL or state audit on classification. Apply on Form 8952 at least 120 days before you want to start treating them as employees.
VCSP settles federal employment tax only, not state tax or wage claims, though the IRS says it does not share VCSP applications with the DOL or states.
If the IRS is already asking, Section 530 relief can cancel the federal employment tax bill if you filed every required 1099, never treated anyone in a similar role as an employee, and had a reasonable basis such as a court ruling, a prior IRS audit, or long-standing industry practice. Bring in a CPA or employment attorney at this point: the answer turns on your documents, and state exposure is separate.
Can the IRS just tell me?
Slowly. Form SS-8 asks the IRS to determine a worker's federal tax status, with no fee, but expect at least six months. The IRS will not rule on hypothetical situations, and the answer covers federal tax only.
What to do next
- List everyone you pay outside payroll and run each through the three IRS categories and your state's test, using IRS Publication 15-A for industry examples.
- Collect a Form W-9 from every genuine contractor before the first payment, and track who crosses $2,000 in 2026.
- If someone turns out to be an employee, follow the checklist for hiring your first employee and budget for FICA, FUTA, and state unemployment.
- If you've been paying employees as contractors, talk to a CPA about VCSP before you switch, since it needs 120 days' notice.
- For the people who belong on payroll, CheckMate calculates federal and state withholding, FICA, FUTA, and state unemployment, pays by direct deposit, and produces W-2s, 1099-NECs, and Form 941. It charges only when you run payroll, with no monthly fee.
FAQ
Can a part-time or short-term worker be a contractor? Not because of the hours. A part-time barista you schedule and train is an employee; how long the relationship lasts is one factor among many, not a switch.
Does paying someone's LLC make them a contractor? Not by itself; the test still looks at the working relationship. An LLC taxed as a corporation generally does not get a 1099-NEC, and California's business-to-business exemption requires meeting a list of conditions, not just having an entity.
Is my nanny or housekeeper a contractor? Usually not. The IRS says a household worker is your employee "if you can control not only what work is done, but how it is done"; an agency worker the agency controls is not. See the nanny tax for what you owe.
Sources
- IRS, Independent contractor (self-employed) or employee? — https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee
- DOL, Field Assistance Bulletin 2025-1 — https://www.dol.gov/sites/dolgov/files/WHD/fab/fab2025-1.pdf
- DOL, Independent contractor rulemaking (2024 rule) — https://www.dol.gov/agencies/whd/flsa/misclassification/rulemaking
- DOL, 2026 independent contractor rulemaking — https://www.dol.gov/agencies/whd/flsa/misclassification/2026rulemaking
- DOL, Fact Sheet #13: Employment Relationship Under the FLSA — https://www.dol.gov/agencies/whd/fact-sheets/13-flsa-employment-relationship
- California DIR, Independent contractor FAQ (ABC test) — https://www.dir.ca.gov/dlse/faq_independentcontractor.htm
- California Labor Code §226.8 — https://leginfo.legislature.ca.gov/faces/codes_displaySection.xhtml?lawCode=LAB§ionNum=226.8
- Massachusetts General Laws c.149 §148B — https://malegislature.gov/Laws/GeneralLaws/PartI/TitleXXI/Chapter149/Section148B
- NJDOL, ABC test regulations announcement (May 5, 2026) — https://www.nj.gov/labor/lwdhome/press/2026/20260505_ABC.shtml
- DOL, State labor offices — https://www.dol.gov/agencies/whd/state/contacts
- IRS, Form W-9 — https://www.irs.gov/forms-pubs/about-form-w-9
- IRS, Publication 15 (2026), Employer's Tax Guide — https://www.irs.gov/publications/p15
- IRS, Backup withholding — https://www.irs.gov/businesses/small-businesses-self-employed/backup-withholding
- IRS, Instructions for Forms 1099-MISC and 1099-NEC — https://www.irs.gov/instructions/i1099mec
- IRS, General Instructions for Forms W-2 and W-3 (2026) — https://www.irs.gov/instructions/iw2w3
- IRS, General Instructions for Certain Information Returns — https://www.irs.gov/instructions/i1099gi
- 26 U.S.C. §3509 — https://www.law.cornell.edu/uscode/text/26/3509
- IRS, VCSP frequently asked questions — https://www.irs.gov/businesses/small-businesses-self-employed/voluntary-classification-settlement-program-vcsp-frequently-asked-questions
- IRS, Failure to deposit penalty — https://www.irs.gov/payments/failure-to-deposit-penalty
- IRS, Information return penalties — https://www.irs.gov/payments/information-return-penalties
- IRS, About Form 8919 — https://www.irs.gov/forms-pubs/about-form-8919
- IRS, Topic 759, FUTA — https://www.irs.gov/taxtopics/tc759
- IRS, Voluntary Classification Settlement Program — https://www.irs.gov/businesses/small-businesses-self-employed/voluntary-classification-settlement-program
- IRS, Instructions for Form 8952 — https://www.irs.gov/instructions/i8952
- IRS, Worker reclassification: Section 530 relief — https://www.irs.gov/government-entities/worker-reclassification-section-530-relief
- IRS, About Form SS-8 — https://www.irs.gov/forms-pubs/about-form-ss-8
- IRS, Instructions for Form SS-8 — https://www.irs.gov/instructions/iss8
- IRS, Publication 15-A, Employer's Supplemental Tax Guide — https://www.irs.gov/publications/p15a
- IRS, Publication 926 (2026), Household Employer's Tax Guide — https://www.irs.gov/publications/p926