Calling someone a "contractor" doesn't make them one. The IRS, the Department of Labor, and your state all have their own tests, and they don't always agree. Misclassification is one of the most expensive mistakes a small business can make — back wages, taxes, benefits, and penalties add up fast.
The IRS looks at behavioral control (who controls how the work is done), financial control (does the worker have a real chance of profit/loss), and the type of relationship (written contracts, benefits, exclusivity).
The Department of Labor focuses on whether the worker is economically dependent on the business or genuinely in business for themselves. The 2024 final rule weighs 6 factors, with no single factor controlling.
California (and a growing list of states) use a 3-part ABC test that classifies workers as employees unless the business can prove all three factors. AZ, NV, NM, and TX use various versions of the common-law test.
If a worker is reclassified as an employee, you can owe back wages, overtime, payroll taxes, unemployment contributions, workers' comp, benefits, and statutory penalties. The IRS can also assess significant penalties for unpaid taxes.
Use a written independent contractor agreement, ensure the contractor invoices you and has other clients, doesn't use your equipment exclusively, and has real autonomy over how work is done. Documentation supports the classification.
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