The determination of whether a worker is an employee or an independent contractor has wide-ranging ramifications for both the company for which work is being performed and the person doing it. The matter of worker classification is ongoing because there is no single definition that can be relied upon. A worker could be an employee for one purpose but an independent contractor for another. What’s more the determination of worker classification may depend on where your company is located. Here’s what we know and what we need to know to avoid problems for our businesses.
DOL rule
On February 27, 2026, the Department of Labor’s Wage and Hour Division issued a lengthy (146 pages) proposed rule on worker classification. The rule applies for purposes of federal minimum wage and overtime as well as the Family and Medical Leave Act. This proposed rule would rescind a 2024 final rule which, among other things, treated workers as employees if their work was integral to the company’s business, and provides new guidance for companies on classifying workers. The proposed rule would:
- Apply an “economic reality” test to determine whether a worker is in business for himself or herself as an independent contractor or is an employee economically dependent on an employer for work.
- Identify and explain 2 “core factors” to help determine if a worker is economically dependent on an employer for work or in business for him- or herself: (1) the nature and degree of control over the work and (2) the worker’s opportunity for profit or loss based on initiative and/or investment.
- Identify other factors to help determine a worker’s status as an employee or independent contractor (e.g., the amount of skill required for the work, degree of permanence of the working relationship; whether the work is part of an integrated unit of production).
- Advise that the actual practice of the worker and the potential employer is more relevant than what may be contractually or theoretically possible.
The proposed rule contains 8 fact-specific examples applying the factors to real-life circumstances.
Note: The DOL is accepting comments on the proposed rule through April 28, 2026, before any final rule is issued.
IRS criteria
For purposes of federal wages withholding, FICA taxes, and federal unemployment tax, the IRS says what matters is the right to control the details of how services are performed. More specifically, the IRS uses a 3-prong test to make this determination:
- Behavioral control
- Financial control
- Relationship of the parties
And if things weren’t complicated enough, there are 4 categories of statutory employees. These are: (1) driver who distributes meat, bakery products, etc., (2), full-time life insurance agent, (3) homeworkers (who work on piece goods), and (4) traveling/city salesperson. Their wages are reported on Form W-2, but they can deduct their business expenses as an independent contractor on Schedule C of Form 1040 or 1040-SR.
State-level ABC test
A number of states, including California, use an “ABC test” for determining worker classification for purposes of unemployment insurance, wage orders, and certain other matters. Under this test, a worker is treated as an independent contractor only if:
- That the worker is free from the control and direction of the hirer in connection with the performance of work, both under the contract for the performance of work and in fact,
- That the worker performs work that is outside the usual course of the hiring entity’s business, and
- That the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
It has been deduced from this test that if a company engages a worker to do just about anything that’s central to the company’s business (e.g., a car repair company hiring a worker to repair brakes), that worker is an employee. In other words, Test B is a killer for companies that would prefer to treat workers (not necessarily this auto mechanic) as independent contractors. But states have carved out exemptions for certain workers (e.g., California’s exemption for app-based drivers for rideshare or delivery services.
Final thought
These aren’t the only rules related to worker classification. For example, the qualified business income (QBI) deduction is barred for 3 years to someone who leaves a job to work as an independent contractor for the same firm. And to make matters worse, the cost of misclassification can be steep… employment taxes with interest and penalties, back benefits (e.g., employer retirement plan contributions), and increased state unemployment insurance costs. So, the bottom line: Get worker classification right, which may require professional advice.
Special Note: On March 5, 2026, a new bill entitled the 21st Century Workers Act (S. 4010) was introduced in the Senate. If enacted, it would create clear definitions of employees and independent contractors for federal tax purposes. As Sen. Mike Lee, who introduced the bill said: “[It] will simplify employee classifications to cut red tape around hiring independent contractors and flexible work arrangements.”
More on the topic of worker classification can be found in this list of blogs.
