Last Updated on September 12, 2025 by MyHRConcierge

Classification of workers as employees or independent contractors has significant implications for organizations—impacting payroll taxes, labor protections, unemployment insurance, and compliance risk. This article outlines federal standards, explores state-level variation, and highlights essential classification tests, including the Common Law Test, the ABC Test, and other noteworthy developments.

Federal Frameworks: IRS, FLSA and DOL Guidance

Common Law Test (IRS Standard)

The Internal Revenue Service (IRS) relies on the Common Law Test, evaluating three categories of factors to discern whether a worker is an employee or independent contractor:

1. Behavioral – Does the company control or have the right to control what the worker does and how the worker does the job?
2. Financial – Who controls financial aspects such as reimbursement, tools and payment? Are the business aspects of the worker’s job controlled by the payer?
3. Type of Relationship – Are there written contracts or employee-type benefits (i.e. pension plans insurance, vacation pay, etc.)? Will the relationship continue, and is the work performed a kay aspect of the business?

These factors are assessed holistically; no single factor is determinative, and thorough documentation of the decision is essential.

FLSA and the Economic Reality Test

Under the Fair Labor Standards Act (FLSA), the Department of Labor (DOL) applies the Economic Reality Test, focused on whether a worker is economically dependent on the employer for work, or instead is in business for themselves. Every factor should be evaluated, as no single element solely determines a worker’s classification. Likewise, no individual factor- or group of factors- carries greater weight than the others. Instead, the assessment should focus on the overall circumstances of the working relationship. Key factors include:

• Opportunity for profit or loss depending on managerial skill
  • Looks at whether a worker can earn profits or suffer losses through their own independent effort and decision making.
• Investments by the worker and employer
  • Looks at whether the worker makes investments that are capital or entrepreneurial in nature.
• Permanence of the work relationship
  •  Looks at the nature and length of the work relationship (sporadic or project-based with a fixed end date vs. regularly occurring fixed periods of work).
• Nature and degree of control
  • Looks at the level of control the potential employer has over the performance of the work and the economic aspects of the working relationship. 
• Whether the work performed is integral to the employer’s business
  • Looks at whether the work is critical, necessary or central to the potential employer’s principal business, which indicates employee status.
• Skill and initiative
  • Looks at whether the worker uses their own specialized skills together with business planning and effort to perform the work and support or grow a business.

On March 11, 2024, a DOL Final Rule reaffirmed reliance on this multifactor test, not adopting an ABC-style approach. However, in May 2025, the DOL issued a Field Assistance Bulletin (FAB No. 2025-1) stating that it would no longer use that more prescriptive 2024 rule, but instead will revert to the prior “economic realities” test.

Statutory Employee Exception

Certain workers may be considered statutory employees– technically independent contractors under common law but treated as employees for tax withholding. Examples include drivers delivering goods for a single client, life insurance agents, a full-time traveling or city salesperson, or home-based workers supplied with materials and specifications.

State-Level Standards: Common Law vs. ABC Test

Many states mirror the IRS common law approach, while others have adopted the ABC test or a modified version of the ABC test.

The ABC Test

The ABC Test is a legal standard used in many U.S. states to determine whether a worker should be classified as an employee or an independent contractor. It is often stricter than the federal Common Law Test, making it harder for businesses to classify workers as independent contractors.

To classify someone as an independent contractor under the ABC Test, all three of the below must be met:

1. Autonomy: The worker is free from the control and direction of the hiring entity in performing the work, both under the contract and in actual practice.
2. Business Relationship: The work performed is outside the usual course of the hiring entity’s business.
3. Customarily Independent: The worker is customarily engaged in an independently established trade, occupation or business of the same nature as the work performed.

If a business cannot satisfy all three prongs, the worker is generally considered an employee under the law in that jurisdiction.

State Approaches

World Population Review, an organization providing demographic and socioeconomic data, has compiled a list of independent contractor laws by state for 2025. According to World Population Review, here are which states are using which approach:

• Common-Law Test: Alabama, Arizona, Florida, Iowa, Kentucky, Michigan, Minnesota, Mississippi, Missouri, New York, North Carolina, North Dakota, South Carolina South Dakota and Texas.
• ABC Test: Alaska, Arkansas, California, Connecticut, Delaware, Georgia, Hawaii, Illinois, Indiana, Kansas, Louisiana, Maine, Maryland, Massachusetts, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, Ohio, Oregon, Rhode Island, Tennessee, Utah, Vermont, Washington and West Virginia.
• Modified ABC Test: Colorado, Idaho, Montana, Pennsylvania, Wisconsin and Wyoming.

Divergence and Risk

It is possible for a worker to be considered a contractor under federal tests but an employee under state ABC rules. For example, IRS may accept contractor status under Common Law, but a state using ABC could deem that worker an employee for unemployment or workers’ compensation purposes.

Compliance Checklist for Employers

1. Assess federal obligations
   • Use IRS Common Law Test for tax withholding
   • Apply FLSA Economic Reality Test for wage/pay protections
2. Identify state-level rules
   • Determine whether your state uses Common Law or ABC Test (and any variants)
   • In ABC states, ensure all three prongs are satisfied to justify contractor status
3. Use Form SS-8 when unclear
   • When classification remains uncertain, consider submitting Form SS-8 to the IRS for formal determination (expect up to six months for a response)
4. Document thoroughly
   • Maintain clear records on control, investment, contracts, benefits, duration and independence.
5. Monitor changes
   • Stay current on Federal updates (e.g. DOL guidance changes in 2025) and state legislative shifts.

Confident Worker Classification

Correctly classifying workers is both legally and financially critical. Federal standards (IRS and FLSA) hinge on multifactor analysis of control and economic dependence. State standards vary: common law rules exist side by side with more stringent ABC Tests. With growing complexity- particularly in the gig economy and across state lines– businesses must stay vigilant, making informed well-documented decisions to mitigate risk.

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