Topic 03 of 6
Employee vs Contractor
Worker Classification
Misclassifying workers is one of the most penalised and most common legal errors small businesses make. The IRS, Department of Labor, and most states have specific tests to determine whether a worker is an employee or an independent contractor — and your agreement with the worker does not determine the classification. The nature of the working relationship does.
Signposting tool only — not legal advice. This page explains what this area involves and points you to official government sources. It does not assess your situation or tell you what to do. Consult a licensed attorney for your specific circumstances.
Option B — Awareness Checklist
Things to be aware of in this area
This is not a compliance checklist. These items flag areas worth exploring — they are not a substitute for professional legal review. Ticking all boxes does not mean you are compliant.
I understand that calling someone a contractor in a contract does not make them one legally
I know the IRS uses a multi-factor test (behavioral control, financial control, relationship type) to classify workers
Workers who are integral to my core business operations are more likely to be classified as employees
I know that misclassification can result in back taxes, penalties, and unpaid benefits claims
I have checked the IRS guidelines for any worker I am classifying as a contractor
Workers who use their own tools and set their own hours are more likely to qualify as contractors
I am aware that some states (including California) use stricter tests than the federal standard
I issue 1099-NEC forms to contractors paid $600 or more in a year
I know that the DOL and IRS can audit worker classification independently — a contractor who sues for benefits can trigger both
I have access to the IRS Form SS-8 process if I am unsure how a worker should be classified
Official Resources
Where to get authoritative information
🤝
SCORE — HR and Employment Mentors
Free mentoring from professionals with HR and employment law backgrounds. Can help you think through classification before engaging a lawyer.
https://www.score.org/find-mentor →
FAQ
I always use contractors — am I at risk?
Potentially yes, if those contractors would be classified as employees under the legal tests. The label in your agreement does not control the classification — the nature of the relationship does. Key risk factors: you control how and when the work is done; the work is central to your business; the worker works exclusively or primarily for you; you supply tools and equipment. If any of these apply, you may have an employee, not a contractor, regardless of what your paperwork says. Use the IRS checklist at irs.gov as a starting point.
FAQ
What are the actual penalties for misclassification?
They can be significant. Federal penalties include: back payroll taxes (employer and employee shares), interest, and penalties for failure to withhold. The IRS can assess these going back three or more years. The DOL can require payment of back overtime and minimum wage. Workers can also file civil claims for unpaid benefits. Some states have additional penalties. The IRS voluntary classification settlement program (VCSP) allows some businesses to proactively correct classification in exchange for reduced penalties — see irs.gov/vcsp.
FAQ
Can I just ask the IRS to decide?
Yes. IRS Form SS-8 allows either a business or a worker to request an official IRS determination of employment status for a specific worker. The process takes several months and the determination applies only to that worker-relationship. It is not a substitute for legal advice, but it provides a formal ruling you can rely on. Find it at irs.gov/forms-pubs/about-form-ss-8.