Employee or independent contractor?

Why it matters

You must cover employees, but not true independent contractors. Calling someone a contractor or paying them on a 1099 does not make them one. If a state decides the worker was really your employee, you can owe the worker's benefits, back premium, and penalties. Misclassification is one of the most common workers' comp problems for small businesses.

There is more than one test

Different laws use different tests, and a worker can be a contractor for one purpose and an employee for another.

• State workers' comp law decides who must be covered for workers' comp.
• The IRS uses a common-law test for federal taxes.
• The U.S. Department of Labor uses an "economic reality" test for minimum wage and overtime.
• Many states use a stricter ABC test for some or all purposes.

The ABC test

Under an ABC test, a worker is an employee unless the business proves all three of these:

• A: The worker is free from your control and direction, both on paper and in practice.
• B: The work is outside the usual course of your business.
• C: The worker is regularly in an independent trade or business of the same kind.

Examples from the states

California uses the ABC test for workers' comp for injuries on or after July 1, 2020, with some exceptions for certain jobs. Massachusetts presumes workers are employees unless a similar three-part test is met. New York presumes a construction worker is the contractor's employee unless a three-part test is met, and a business entity must meet twelve separate criteria to be treated as a separate business. Other states use a list of factors about control. Check your state guide.

The IRS view

For federal taxes, the IRS looks at three kinds of evidence:

• Behavioral control: do you control what the worker does and how they do it?
• Financial control: do you control how they are paid, whether expenses are repaid, and who supplies tools?
• Relationship: is there a contract, are there benefits, will the work continue, and is it a key part of your business?

Signs of a real contractor

No single factor decides the question, but true contractors usually:

• Set their own hours and decide how to do the work.
• Have their own business license, insurance, tools, and equipment.
• Work for other clients and advertise to the public.
• Send invoices and can make or lose money on a job.
• Carry their own workers' comp if they have employees.

Protect your business

Use written contracts, but know that the real working relationship matters more than the paperwork. Get a certificate of insurance from every contractor before work starts. If you are unsure, ask your state workers' comp agency or an employment lawyer. When in doubt, many businesses choose to cover the worker.