How Do I Know if a Worker Is an Employee or an Independent Contractor?

By Bill Stilwell · Last reviewed October 18, 2026

The short answer

Whether a worker is an employee or a contractor depends on the real working relationship, not on what you call it or what the contract says. The Internal Revenue Service (IRS) looks at behavioral control, financial control, and the relationship of the parties. The U.S. Department of Labor (DOL) uses an “economic reality” test for wage and overtime law, and states can use their own tests, some stricter. If you’re unsure, get professional advice before the work starts.

Why it matters

A house cleaning company calls its cleaners “contractors” but sets their schedules, trains them, supplies everything, and pays by the hour. That looks a lot like employment. If one is hurt on the job or files for unemployment, the business may owe payroll taxes, penalties, and workers’ compensation costs it never planned for.

23.3.1 Relationship

What it means: look at the actual working relationship.

How to do it: describe how the work really happens: who sets the hours, who supplies tools, how the person is paid, whether they work for others, and how long the arrangement lasts. The IRS also looks at whether there are written contracts, employee-type benefits, whether the relationship is expected to continue, and whether the work is a key part of your regular business.

Common mistake: relying on the title “contractor” or a signed agreement while treating the person like staff.

23.3.2 Control

What it means: who controls the work, methods, schedule, and tools.

How to do it: answer honestly. Do you tell them how to do the work, train them on your methods, set their hours, or supply the tools? The IRS calls this behavioral control. The more of it you have, the more the person looks like an employee.

Common mistake: requiring a contractor to follow your full procedures manual and attend daily meetings.

23.3.3 Economic dependence

What it means: whether the worker runs their own independent business.

How to do it: look at whether they invest in their own tools and business, can make a profit or take a loss, market their services to others, set their own prices, and have other clients. The IRS calls this financial control. The DOL’s economic reality test asks whether the worker is in business for themselves or depends on your business for work.

Common mistake: “contractors” who work only for you, full time, for years, using your equipment.

23.3.4 Industry rules

What it means: which classification tests apply to you.

How to do it: check all three levels.

Federal tax: the IRS common-law rules above.
Federal wage law: the DOL economic reality test under the Fair Labor Standards Act (FLSA). This rule has changed several times. A 2024 rule took effect March 11, 2024. In May 2025, the DOL said its investigators would use its older guidance instead of the 2024 rule, though the 2024 rule still applied in private lawsuits. In February 2026, the DOL proposed a new rule. Check the DOL website for the current status before you decide.
State law: many states use their own tests for unemployment, workers’ compensation, and wage laws, and some are stricter than federal rules. Check your state labor department and state tax agency.

Some industries also have special rules, so ask your trade association.

Common mistake: passing the IRS test and assuming the state will agree.

23.3.5 Documentation

What it means: keep accurate agreements and records.

How to do it: for each contractor, keep a written agreement (see 11.2.2 Independent-Contractor Agreement), their business information, invoices they send you, proof of their insurance if required (see 11.2.6 Insurance Certificates From Vendors), and your classification checklist. Collect the tax form your tax professional tells you to collect and file the information returns required for contractors (see 10.3.5 Information Returns).

Common mistake: paying contractors from a list of hours you tracked yourself instead of invoices they send.

23.3.6 Professional review

What it means: get advice when the answer isn’t clear.

How to do it: talk to an employment attorney or certified public accountant (CPA) before the work starts. You can also ask the IRS to decide a specific worker’s status for federal tax purposes by filing Form SS-8, though that process takes time.

Common mistake: waiting until a worker files for unemployment or gets hurt to ask the question.

When to get help from a pro

This page is marked professional review required. An employment attorney and a CPA can look at your real arrangement under federal and state rules. Questions to ask:

Based on how this person really works, are they an employee or a contractor under IRS, DOL, and my state’s tests?
What changes would I need to make for a true contractor relationship?
If I’ve classified someone wrong in the past, what are my options to fix it?

Bill’s note

[Bill: add a short note. For example, how you decided whether SiteSmarty’s first helpers would be contractors or employees, and who you asked for advice.]

How I did this for SiteSmarty

[Date I did this:]
[What I actually did, step by step: how I reviewed each SiteSmarty worker’s classification and who checked it]
[What it cost and how long it took:]
[What surprised me or what I’d do differently:]
[Screenshot or photo to add, with private info blurred: the classification checklist for one worker]
[Result so far:]

Questions people ask

Does a contractor agreement make someone a contractor? No. The IRS, DOL, and states look at how the work really happens. The agreement is only one factor.

What are the IRS rules? The IRS looks at behavioral control, financial control, and the relationship of the parties.

Do states have different rules? Yes. Many states use their own tests, and some are stricter. Check your state labor department and tax agency.

What if I’m still not sure? Talk to an employment attorney or CPA. For federal tax, you can ask the IRS to decide by filing Form SS-8.

Audit check

Outline line	Question	Pass looks like	Fail looks like	Evidence to collect
23.3.1 Relationship	Is the real working relationship described for each worker?	Written description	Title only	Classification checklist
23.3.2 Control	Is control over work, schedule, and tools reviewed?	Honest answers recorded	Not reviewed	Checklist
23.3.3 Economic dependence	Is the worker’s business independence reviewed?	Other clients, own tools, own pricing	Works only for you on your equipment	Checklist and invoices
23.3.4 Industry rules	Were IRS, DOL, and state tests checked?	All three checked and dated	Federal tax only	Checklist with sources
23.3.5 Documentation	Are agreements, invoices, insurance, and tax forms on file?	Complete file per contractor	Missing agreement or invoices	Contractor file
23.3.6 Professional review	Was advice obtained when unclear?	Notes from attorney or CPA	No advice on unclear cases	Advice record

Where this fits

Do this first: 23.2 Defining a Role

Do this next: 10.3.1 State Employer Registration

Sources

IRS, "Topic no. 762, Independent contractor vs. employee" (checked October 18, 2026)
U.S. Department of Labor, Wage and Hour Division, "Small Entity Compliance Guide" on employee or independent contractor classification (checked October 18, 2026)
U.S. Department of Labor, Field Assistance Bulletin No. 2025-1 (checked October 18, 2026)
U.S. Small Business Administration, "Hire and manage employees" (checked October 18, 2026)

This page explains general rules and Bill's own experience. It is not legal, tax, or insurance advice. Talk to a qualified professional about your situation.