Independent Contractor vs. Employee: How the Tests Work

Overview

Whether a worker is an employee or an independent contractor determines tax withholding, unemployment insurance, workers' compensation, wage-and-hour obligations, and benefits eligibility. Misclassification can lead to back taxes, penalties, and liability for unpaid benefits. There is no single test. Different agencies and different laws apply different tests, and a worker can be a contractor under one law and an employee under another.

Key Terms

• Misclassification: Treating a worker as an independent contractor when the law treats the worker as an employee.
• Common-law test: The traditional IRS test focused on the employer's right to control the worker.
• Economic reality test: The Department of Labor's test under the Fair Labor Standards Act, focused on whether the worker is economically dependent on the business.
• ABC test: A stricter test used by some states for unemployment insurance and wage claims. Utah's unemployment insurance program applies an ABC-style test.
• Form SS-8: The IRS form a business or worker can file to request an official worker-status determination.

Why Classification Matters

Employees trigger payroll tax withholding, employer FICA contributions, unemployment insurance premiums, workers' compensation coverage, and wage-and-hour compliance. Independent contractors generally handle their own taxes and are not covered by those employer obligations. Because the financial difference is large, agencies scrutinize the substance of the working relationship, not just what the contract calls the worker.

The Tests Courts and Agencies Use

IRS common-law factors. The IRS examines the degree of control and independence, grouped into three categories: behavioral control (does the business control what the worker does and how the worker does it, including instructions and training), financial control (does the business control the economic aspects, such as how the worker is paid, whether expenses are reimbursed, and whether the worker can realize profit or loss), and the relationship of the parties (written contracts, benefits, permanency of the relationship, and whether the work is a key aspect of the business). These factors trace back to Revenue Ruling 87-41 and related IRS guidance. No single factor decides the outcome.

DOL economic reality test. Under the Fair Labor Standards Act (29 U.S.C. § 203), the Department of Labor applies an economic reality test asking whether the worker is economically dependent on the business or truly in business for themselves. The Department's 2024 final rule uses six factors evaluated as a whole: opportunity for profit or loss, investments by the worker and the business, permanence of the relationship, nature and degree of control, whether the work is integrated into the business, and the worker's skill and initiative. Like the IRS test, it is a totality-of-the-circumstances analysis.

The ABC test. Some states use a stricter test, most notably for unemployment insurance and wage claims. Under the ABC test, a worker is presumed to be an employee unless the business proves: (A) the worker is free from the business's control in performing the work, (B) the work is outside the usual course of the business, and (C) the worker is customarily engaged in an independently established trade of the same nature. Utah's Department of Workforce Services applies an ABC test for unemployment insurance purposes. California's AB5 law (Labor Code § 2775) applies a version of the ABC test to wage orders and the Labor Code.

Utah's approach. Utah does not use one universal test. Unemployment insurance, workers' compensation, and tax withholding each have their own definitions and analyses, so the same working relationship can be classified differently by different Utah agencies.

Common Mistakes

• Assuming a signed "independent contractor agreement" settles the question. Agencies look at actual working conditions, not labels.
• Assuming that issuing a Form 1099 makes someone a contractor.
• Applying one agency's result to all purposes, for example treating an IRS determination as binding for Utah unemployment insurance.
• Exerting day-to-day control (set hours, required training, detailed methods) while calling the worker a contractor.
• Engaging full-time, indefinite, core-function workers as contractors without examining the ABC test's "outside the usual course of business" prong.