Independent Contractor vs Employee Test: What You Need to Know

If you're building a freelance business or hiring remote workers, understanding the independent contractor vs employee test isn't just important—it's essential. In 2025, more than 70 million Americans are estimated to be part of the gig economy, representing approximately 36 percent of the total workforce. With the freelance economy booming and projections suggesting by 2027, 86.5 million people will be freelancing in the United States, getting worker classification right has never been more critical.

Misclassification isn't a minor paperwork error—it can cost businesses hundreds of thousands of dollars in back taxes, penalties, and legal fees. Let's break down everything you need to know about properly classifying workers in today's evolving freelance landscape.

Why Worker Classification Matters More Than Ever

The distinction between an independent contractor and an employee affects everything from tax obligations to legal protections. It is critical that business owners correctly determine whether individuals providing services are employees or independent contractors, as employers must withhold and deposit income taxes, Social Security taxes and Medicare taxes from wages paid to an employee, and also pay the matching employer portion of Social Security and Medicare taxes as well as unemployment tax.

For independent contractors, none of these taxes are withheld by the hiring company. Instead, freelancers handle their own tax obligations—a key advantage that provides flexibility but requires financial discipline.

The Federal Tests: IRS Classification Standards

The IRS uses three main categories to determine worker status: behavioral control, financial control, and the relationship between parties. In determining whether the person providing service is an employee or an independent contractor, all information that provides evidence of the degree of control and independence must be considered, with facts falling into three categories: Behavioral, Financial, and Relationship.

Behavioral Control

Behavioral control examines whether the company controls what the worker does and how they do their work. Key questions include: Does the business provide detailed instructions? Is training required? Can the worker set their own schedule?

An individual working remotely is your employee under the common-law rules, if you can control what will be done and how it will be done—even if they're working from a home office across the country. This is crucial for remote freelancers to understand: location doesn't determine classification; control does.

Financial Control

Financial control looks at the business aspects of the relationship. True independent contractors typically have unreimbursed business expenses, invest in their own equipment, and can realize a profit or loss from their work. They often work with multiple clients simultaneously and advertise their services to the broader market.

If you're a freelancer working exclusively for one client, using their equipment, and receiving a regular salary-like payment, you may actually be an employee in the eyes of the IRS—regardless of what your contract says.

Relationship Factors

This category examines how the parties view their relationship. Do they have a written contract? Are employee-type benefits provided? Is the relationship ongoing or project-based? There is no magic or set number of factors that makes the worker an employee or an independent contractor and no one factor stands alone in making this determination—the keys are to look at the entire relationship and consider the extent of the right to direct and control the worker.

State-Level Tests: The ABC Test and Beyond

While federal classification is important, many states have their own tests that can be more restrictive. Currently, the U.S. Department of Labor and 33 states use the ABC Test. California remains the strictest state for contractor classification through the ABC Test under AB 5.

The ABC Test presumes all workers are employees unless the hiring entity can prove all three conditions:

• A: The worker is free from control and direction in performing the work
• B: The work performed is outside the usual course of the hiring entity's business
• C: The worker is customarily engaged in an independently established trade or business

Part B is particularly challenging. Prong B is not satisfied when a clothing manufacturing company hires work-at-home seamstresses to make dresses from cloth and patterns supplied by the company that will thereafter be sold by the company. If you're doing the core work of the business, you're likely an employee under this test.

The 2026 Regulatory Landscape

The regulatory environment continues to evolve. In May 2025, the U.S. Department of Labor announced it would no longer enforce the 2024 independent contractor rule issued under the Biden Administration, and starting May 1, 2025, DOL will evaluate independent contractor status using traditional economic reality principles.

This shift has created a mixed landscape where federal enforcement may be more flexible, but states are moving in different directions, ensuring classification will remain a priority for employers in 2026.

Practical Steps for Freelancers and Businesses

Whether you're hiring contractors or working as one, here's how to stay compliant:

For Freelancers

• Maintain multiple clients to demonstrate independence
• Invest in your own equipment and workspace
• Market your services publicly through a website or professional profiles
• Use written contracts that clearly outline project scope and deliverables
• Keep detailed records of business expenses
• Set your own schedule and methods for completing work

For Businesses Hiring Contractors

• Focus on results, not the process of how work gets done
• Avoid providing training on company-specific procedures
• Don't require contractors to use your equipment or software
• Structure payments per project or milestone, not hourly wages
• Don't offer employee benefits like health insurance or paid time off
• Maintain written independent contractor agreements

When You're Uncertain

If it is still unclear whether a worker is an employee or an independent contractor after reviewing the three categories of evidence, then Form SS-8 can be filed with the IRS, which will review the facts and circumstances and officially determine the worker's status—though it can take at least six months to get a determination.

Remember, the hiring entity cannot unilaterally determine a worker's status simply by assigning the worker the label independent contractor or by requiring the worker to enter into a contract that designates the worker an independent contractor. The actual working relationship—not the contract language—determines classification.

The Bottom Line

With the freelance market expected to surge to $8.39 billion by 2025, growing at an annual rate of 14.5%, understanding worker classification tests is essential for anyone participating in the gig economy. Whether you're building a freelance business or hiring remote contractors, taking time to properly classify workers protects everyone involved.

The independent contractor vs employee distinction isn't about choosing the most convenient label—it's about accurately reflecting the nature of your working relationship. Get it right from the start, and you'll avoid costly penalties while building a sustainable, compliant freelance business in this rapidly growing economy.

For more detailed guidance, consult the IRS Independent Contractor guidelines or seek advice from an employment attorney familiar with your state's specific requirements. As regulations continue to evolve, staying informed is your best protection in the dynamic world of independent work.