Learn how a worker is classified as an employee or contractor by each state.
On average, ten to twenty percent of independent contractors are misclassified. Even when the error is unintentional, misclassification results in legal and financial penalties. Do you know how to tell if you’ve hired a W-2 employee or a 1099 independent contractor/freelancer? This guide explains the two primary tests utilized and which states use each test.
Worker Classification Tests
The two primary tests used in the US for worker classification are the Common Law Test and the ABC Test. While the ABC Test is similar to the Common Law Test, it contains more stringent standards for classification. So these two tests determine whether a worker is an employee or an independent contractor, also called “1099 workers.”
Because of the differences between the tests, a worker could be classified as an independent contractor with the Common Law Test but as an employee with the ABC Test.
Companies pay independent contractors differently than employees. So for freelancers and independent contractors, companies do not pay payroll taxes or provide benefits. Instead, payments to these workers are reported through Form 1099-NEC. Then the freelancer or contractor is responsible for paying self-employment taxes.
Common Law Test
Currently used by the IRS, 18 states, and the District of Columbia, the Common Law Test decides worker status through evaluating the behavioral control, financial control, and relationship between the company and the worker. Classification as an employee is triggered if the company exercises any of the controls over the worker.
Behavioral Control: Does the company control or have the right to control what the worker does and how the worker does his or her job? (e.g., where work is done; how work is performed)
Financial Control: Are the business aspects of the worker’s job controlled by the payer? (e.g., how paid, reimbursement of expenses, who provides supplies/tools)
Type of Relationship: Are there written contracts or employee type benefits (e.g., pension plan, insurance, vacation pay, etc.)? Will the relationship continue, and is the work performed a key aspect of the business?
The Common Law Test presumes a worker is an independent contractor unless one of the three control factors is utilized by the hiring company. Sometimes the Common Law Test is also referred to as the “Right to Control Test” or “Control and Direction Test.”
ABC Test
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Thirty-three states, most notably California, and the US Department of Labor (DOL) rely on the ABC Test to classify workers. However, the use of the ABC test varies by state — many states do not use all three prongs of the test.
To classify a worker as an independent contractor, each mandated prong must be satisfied. So a worker is presumed to be an employee unless each part of the ABC Test is satisfied.
With the ABC Test, a worker can only be classified as an independent contractor if:
(A) the worker is free from the employer’s control and direction over their work; and
(B) the worker is providing services outside the employer’s usual course of business; and
(C) the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.
As passed through Assembly Bill 5 (AB5), California’s version of the ABC Test is considered the strictest form of the test.
Worker Classification Tests by State
Currently, every state uses its own worker classification test. Below we break down which type of test each state uses. For those states that use the ABC Test, we note which parts of the test they use. Make sure to review the details for each state, as there can be nuances and differences for the tests and how states and courts utilize them to determine worker classification, unemployment insurance, workers’ compensation, and state taxes.
Additionally, state legislatures may change their tests, so always verify that your company follows the latest regulations regarding independent contractor classification tests.
Meeting state compliance reporting requirements
While most states don’t have reporting requirements related to working with independent contractors, quite a few do. For example, in California, your company will need to file form DE 542 Report of Independent Contractor(s) with the California Employment Development Department (EDD). Other states and US territories have similar requirements for reporting work with independent contractors and freelancers. Our post on reporting requirements breaks down what you need to know by state.
Other worker classification rules and regulations
In addition to state classification requirements, make sure that you check for any local worker classification regulations. Municipalities or other local governments may have their own independent contractor classification tests or other rules. For example, New York City’s FIFA applies to companies located in NYC and businesses that work with freelancers there.
Assessing classification compliance risk
Not sure what your risk level is for classification compliance? Assess your risk with our downloadable Freelancer Compliance Risk Checklist. .
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Managing independent contractor compliance
An all-in-one solution for managing independent contractors, freelancers, and vendors, Liquid has the features you need to stay compliant. With Liquid, it’s easy to create and execute Independent Contractor Agreements and Work Orders / Statements of Work. In addition, using Liquid enables you to separate the management of your full-time employees from your freelancers and independent contractors. And your freelancers can use Liquid to create and execute projects with their other clients, reinforcing their independent contractor status. So, it’s time to start simplifying managing independent contractors with Liquid.
