United States — Worker Classification

The Fair Labor Standards Act (FLSA) governs employee vs. independent contractor classification for purposes of federal minimum wage, overtime, and recordkeeping obligations. Whether a worker is an employee entitled to FLSA protections or an independent contractor in business for themself is determined by applying an economic reality test that asks whether the worker is economically dependent on the potential employer for work.

The U.S. Department of Labor Wage and Hour Division codified this framework at 29 CFR Part 795, effective March 11, 2024. The regulation applies a multifactor totality-of-the-circumstances analysis; no single factor is dispositive, and the weight given to each factor depends on the facts of the particular relationship.

## The six economic reality factors

The regulation identifies six non-exhaustive factors as "tools or guides" to assess economic dependence (29 CFR 795.110):

1. Opportunity for profit or loss depending on managerial skill. Whether the worker has opportunities for profit or loss based on managerial skill, initiative, business acumen, or judgment. Relevant facts include whether the worker negotiates pay, accepts or declines work, hires their own workers, purchases materials or equipment, or markets their services. A genuine opportunity to profit (or a business decision not to invest because the potential return does not justify the expense) indicates independent contractor status.

1. Investments by the worker and potential employer. Whether the worker makes capital or entrepreneurial investments that support business growth—increasing clients, reducing costs, extending market reach, or increasing sales. Investments that are capital or entrepreneurial in nature weigh toward independent contractor status; a lack of such investment (or investments that are primarily tools to perform the immediate job) weighs toward employee status.

1. Degree of permanence of the work relationship. The nature and length of the working relationship. Indefinite, continuous relationships suggest employee status; sporadic, project-based work with a fixed ending date (or regularly recurring fixed periods of work) where the worker takes on multiple different jobs suggests independent contractor status.

1. Nature and degree of control. The potential employer's control—including reserved control—over performance of the work and the economic aspects of the relationship. Relevant facts include whether the potential employer sets the worker's schedule, supervises performance (including via technological means), limits the worker's ability to work for others, or controls prices, pay rates, hiring, or firing. Greater control weighs toward employee status; less control weighs toward independent contractor status. Control imposed solely to comply with a specific federal, state, tribal, or local regulation is less probative.

1. Extent to which the work performed is an integral part of the potential employer's business. Whether the work is critical, necessary, or central to the potential employer's principal business. Work that is integral to the employer's business indicates employee status; work that is not integral (ancillary or one step removed from the employer's primary offering) weighs toward independent contractor status.

1. Skill and initiative. Whether the worker uses specialized skills together with business planning and initiative to perform the work and support or grow their own business. Reliance on the employer to provide training for the job (absence of specialized skills) indicates employee status; use of specialized skills in connection with business-like initiative indicates independent contractor status.

Additional factors may be considered if they indicate whether the worker is in business for themself or economically dependent on the potential employer for work.

## What is irrelevant

The regulation expressly states that certain facts do not determine classification (29 CFR 795.105 and DOL Fact Sheet 13): the label or title given to the worker; whether the worker receives a Form 1099; whether the parties have signed an independent contractor agreement; the place where work is performed; whether the worker is licensed by state or local government; and the time or mode of pay.

## Practical consequences

Employees under the FLSA must be paid at least the federal minimum wage ($7.25/hour as of 2026) and overtime premium (one and one-half times the regular rate) for hours worked over 40 per workweek, unless a specific exemption applies. Independent contractors are not entitled to these protections. Misclassification exposes the employer to back-wage liability, liquidated damages, and civil penalties.

## Current regulatory status

The economic reality test codified at 29 CFR Part 795 (effective March 11, 2024) has been the subject of fluctuating regulatory guidance. On May 1, 2025, the DOL Wage and Hour Division issued Field Assistance Bulletin 2025-1 directing investigators not to apply the 2024 rule's analysis in enforcement matters during a regulatory review, instead relying on "longstanding principles outlined in Fact Sheet #13" and Opinion Letter FLSA2019-6. On February 26, 2026, the DOL proposed a new rule (RIN 1235-AA46) that would rescind the 2024 regulation and replace it with an analysis identifying two "core factors" (control and opportunity for profit/loss) given greater weight. The comment period for the proposed rule closed April 28, 2026; no final rule has been published as of May 2026.

Cross-border employers should note that the FLSA test applies only to FLSA coverage. Different tests apply under the Internal Revenue Code (for tax withholding and Form W-2 vs. 1099 reporting), the National Labor Relations Act (for collective bargaining rights), Title VII and other anti-discrimination statutes, ERISA (for benefit-plan coverage), the Family and Medical Leave Act, and state wage-and-hour laws. Many states—including California, New Jersey, Massachusetts, and Illinois—apply a stricter "ABC test" under their own statutes; classification as an independent contractor under the FLSA does not ensure compliance with state law.

Source: 29 CFR Part 795 Source: DOL Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act Source: Final Rule: Employee or Independent Contractor Classification Under the Fair Labor Standards Act, 89 FR 1638 (Jan. 10, 2024) Source: DOL Field Assistance Bulletin 2025-1 (May 1, 2025) Source: Proposed Rule: Employee or Independent Contractor Status Under the FLSA, FMLA, and MSPA, 91 FR 9932 (Feb. 27, 2026)

The Internal Revenue Service applies a common-law test to determine whether a worker is an employee (subject to federal income tax withholding, FICA withholding for Social Security and Medicare, and FUTA unemployment tax) or an independent contractor (who receives Form 1099-NEC and pays self-employment tax). This classification is legally and economically distinct from the FLSA employee-vs.-contractor determination; a worker may be an independent contractor under the common-law test yet still be an employee under the FLSA economic reality test (or vice versa), and state law classifications may differ again.

The stakes for cross-border employers are high. If the worker is a common-law employee, the employer must withhold federal income tax under IRC § 3402, withhold and remit the employee's share of FICA, pay the matching employer share of FICA, and pay FUTA. The employer must issue Form W-2 by January 31 of the following year. If the worker is an independent contractor, the employer has no withholding or matching obligation, reports payments of $600 or more on Form 1099-NEC, and the worker self-reports and pays self-employment tax on Schedule SE.

## Statutory and regulatory foundation

For FICA purposes, 26 USC § 3121(d)(1) defines "employee" as "any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee." The same common-law framework applies to federal income tax withholding (26 USC § 3401(c)) and FUTA (26 USC § 3306(i)).

The Treasury regulation at 26 CFR § 31.3121(d)-1(c) provides that an employer-employee relationship "exists when the person for whom services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result." The regulation further states: "In general, if an individual is subject to the control or direction of another merely as to the result to be accomplished by the work and not as to the means and methods for accomplishing the result, he is an independent contractor."

The right to control—not the exercise of that control—is determinative. An employer who gives an individual complete freedom of action may still have a common-law employee if the employer retains the right to direct how the work is performed.

The regulation expressly provides that labels are immaterial: "If the relationship of employer and employee exists, the designation or description of the relationship by the parties as anything other than that of employer and employee is immaterial. Thus, if such relationship exists, it is of no consequence that the employee is designated as a partner, coadventurer, agent, independent contractor, or the like" (26 CFR § 31.3121(d)-1(a)(3)).

## The three-factor framework: behavioral, financial, and relationship

The IRS condensed decades of common-law precedent into a three-category framework, set out in Publication 15-A (Employer's Supplemental Tax Guide, 2026 edition, Chapter 2) and on the agency's guidance pages. The IRS instructs that "all information that provides evidence of the degree of control and the degree of independence must be considered" and that no single factor is dispositive; the analysis is a totality-of-the-circumstances weighing. The three categories are:

1. Behavioral control

Does the business control or have the right to control what the worker does and how the worker does the job?

Instructions. Publication 15-A explains: "An employee is generally subject to the business's instructions about when, where, and how to work. … The amount of instruction needed varies among different jobs. Even if no instructions are given, sufficient behavioral control may exist if the employer has the right to control how the work results are achieved." Instructions can include when and where to work, what tools or equipment to use, what workers to hire or to assist with the work, where to purchase supplies and services, what work must be performed by a specified individual, and what order or sequence to follow.

The more detailed the instructions, and the more the business retains the right to give them, the stronger the indication of employee status. Conversely, if the business lacks the knowledge to instruct a highly specialized professional and has ceded control over methods, that weighs toward independent contractor status.

Training. "An employee may be trained to perform services in a particular manner. Independent contractors ordinarily use their own methods" (Publication 15-A). If the business requires the worker to attend training sessions, work with an experienced employee, or follow a procedures manual, that indicates the business wants the job done a particular way—hallmark of an employment relationship.

2. Financial control

Does the business control the economic aspects of the worker's job?

Significant investment. "An independent contractor often has a significant investment in the equipment he or she uses in working for someone else" (Publication 15-A). However, the IRS cautions: "in many occupations, such as construction, workers spend thousands of dollars on the tools and equipment they use and are still considered to be employees. There are no precise dollar limits that must be met in order to have a significant investment. Furthermore, a significant investment is not necessary for independent contractor status as some types of work simply do not require large expenditures."

Unreimbursed expenses. Independent contractors are more likely to incur unreimbursed business expenses. Employees typically have fixed business costs reimbursed by the employer or have their expenses covered as part of their regular wage or salary.

Opportunity for profit or loss. Can the worker's managerial skill and business decisions affect profit or loss? An independent contractor can realize a profit by managing expenses efficiently, taking on multiple clients, or hiring subcontractors. A worker paid a guaranteed wage or salary who has no real opportunity to incur a loss is more likely an employee.

Method of payment. "An employee is generally guaranteed a regular wage amount for an hourly, weekly, or other period of time. … An independent contractor is usually paid by a flat fee for the job. However, it is common in some professions, such as law, to pay independent contractors hourly" (Publication 15-A).

3. Type of relationship

How do the parties perceive and structure their relationship?

Written contracts. The IRS guidance is emphatic: "Although a contract may state that the worker is an employee or an independent contractor, this is not sufficient to determine the worker's status. … How the parties work together determines whether the worker is an employee or an independent contractor." The regulation similarly provides that labels are immaterial if the substance is employment.

Employee-type benefits. Does the business provide benefits such as insurance, a pension plan, vacation pay, or sick pay? Offering these benefits indicates an intent to create an employment relationship. Independent contractors ordinarily do not receive employee benefits.

Permanency of the relationship. An indefinite, continuous relationship suggests employment. Work that is project-based, seasonal, or for a specific term with a defined ending date suggests independent contractor status.

Services as a key aspect of the business. The IRS guidance states: "If a worker provides services that are a key aspect of the business, it is more likely that the business will have the right to direct and control his or her activities. For example, if a law firm hires an attorney, it is likely that it will present the attorney's work as its own and would have the right to control or direct that work. This would indicate an employer-employee relationship."

## Cross-border considerations

Remote US workers for foreign entities

For a foreign entity hiring a US-based worker, common-law employee classification may trigger additional tax obligations beyond federal employment taxes. Under many tax treaties (including the OECD Model Tax Convention Art. 5(5)), a US employee who habitually exercises authority to conclude contracts on behalf of the foreign principal may constitute a dependent-agent permanent establishment, exposing the foreign entity to US corporate income tax on profits attributable to the PE and state income or franchise tax in the worker's state. Whether a PE exists is determined under the applicable treaty and is outside the scope of the IRS common-law employment test, but the employment classification is often the starting point for the analysis.

US citizens and residents working abroad

A US citizen or resident alien working remotely abroad for a US employer generally remains subject to US federal income tax withholding and FICA. However, if the worker is employed abroad by an "American employer" (as defined in 26 USC § 3121(h)), FICA may not apply if a totalization agreement is in force between the US and the country where services are performed. The US has totalization agreements with 30 countries, including Canada, the UK, Germany, France, Australia, Japan, and others. These agreements allow the worker to remain covered solely under one country's social insurance system and avoid dual contributions. Employers must obtain a certificate of coverage from the US Social Security Administration or the foreign authority to claim the exemption.

Nonresident alien contractors

For a nonresident alien independent contractor providing services wholly outside the United States, payments are not subject to FICA, FUTA, or federal income tax withholding (provided the services are not effectively connected with a US trade or business). The US payer reports the payments on Form 1042-S (not 1099-NEC) if the individual claims an exemption or reduced rate under a tax treaty using Form W-8BEN.

## Form SS-8 determination

If classification is unclear, either the business or the worker may file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, requesting an official IRS determination. The IRS will analyze the relationship and issue a determination letter. Processing time is typically six months or longer. The determination applies to the specific facts presented and does not provide prospective safe-harbor protection; the IRS may reach a different conclusion if facts change or if the initial submission was incomplete.

## Relief from liability: Section 530 and the Voluntary Classification Settlement Program

If an employer misclassifies a worker as an independent contractor, the IRS may assess back taxes, interest, and penalties. However, Section 530 of the Revenue Act of 1978 (not codified in the Internal Revenue Code) provides relief from employment tax liability if the employer meets all three of the following requirements:

1. Consistent treatment. The employer (and any predecessor) did not treat the worker—or any worker in a substantially similar position—as an employee for any period beginning after 1977.
2. Reporting consistency. The employer filed all required federal tax returns (including Forms 1099) consistent with treating the worker as an independent contractor.
3. Reasonable basis. The employer had a reasonable basis for the non-employee treatment, such as reliance on judicial precedent, published IRS rulings, a past IRS audit that resulted in no employment tax assessment for workers in substantially similar positions, or a long-standing recognized practice of a significant segment of the industry.

Section 530 relief does not change the worker's classification going forward; it merely relieves the employer of past employment tax liability for the covered period. The worker may still file Form 8919 to report and pay the employee share of Social Security and Medicare tax.

The IRS also offers a Voluntary Classification Settlement Program (VCSP), under which an employer can prospectively reclassify workers as employees and pay a reduced amount (effectively 10% of the employment tax liability that would have been due on compensation paid to the workers for the past year), with no interest or penalties. To qualify, the employer must have consistently treated the workers as non-employees, filed all required Forms 1099, and not currently be under audit. The employer applies by filing Form 8952 at least 60 days before the desired effective date.

## Relationship to other federal and state tests

The IRS common-law test applies only to federal employment tax and income tax withholding. Other statutes use different tests:

• Fair Labor Standards Act (minimum wage and overtime): the DOL's economic reality test (29 CFR Part 795), which is broader than common law and more likely to find employee status.
• National Labor Relations Act (collective bargaining rights): the NLRB applies a common-law agency test but weighs factors differently.
• Title VII, ADA, ADEA (anti-discrimination): federal courts use variations of common law, but the multi-factor analysis and weights differ by circuit.
• State unemployment insurance, workers' compensation, and wage-hour laws: many states apply an ABC test (presuming employee status unless the hiring entity proves all three prongs: (A) the worker is free from control, (B) the work is outside the usual course of the hiring entity's business, and (C) the worker is customarily engaged in an independently established trade or occupation). California (for most purposes under AB 5, codified at Cal. Lab. Code § 2750.3), Massachusetts (Mass. Gen. Laws ch. 149, § 148B), New Jersey (N.J. Stat. Ann. § 43:21-19(i)(6)), and Illinois (820 ILCS 185/10) apply ABC tests that are significantly harder to satisfy than the IRS common-law test.

A worker classified as an independent contractor under the IRS common-law test may simultaneously be an employee under the FLSA, the NLRA, Title VII, and state wage-and-hour or unemployment insurance statutes. Cross-border employers engaging US-based contractors must independently analyze each regulatory regime.

Source: 26 USC § 3121(d) — Definitions (FICA) Source: 26 CFR § 31.3121(d)-1 — Who are employees-1) Source: IRS Publication 15-A (2026), Employer's Supplemental Tax Guide Source: IRS: Independent contractor (self-employed) or employee? Source: IRS Topic No. 762, Independent contractor vs. employee

A US business that engages a nonresident alien individual as an independent contractor for services performed outside the United States typically owes no federal employment tax (no FICA, no FUTA, no federal income tax withholding) on the payments, because the services are not US-source income and are not effectively connected with a US trade or business. However, when a nonresident alien contractor performs services within the United States or receives certain types of US-source income (interest, dividends, rents, royalties, or compensation for services performed in the US), the US payer becomes a withholding agent subject to the 30% backup withholding regime under IRC § 1441, unless the contractor provides documentation to claim an exemption or a reduced rate under an applicable income tax treaty.

This withholding obligation is entirely separate from the IRS common-law test for federal employment taxes (described in the IRS common-law test section of this guide) and from the FLSA economic reality test. A worker may be classified as an independent contractor under both the IRS common-law test and the FLSA yet still trigger 30% withholding under § 1441 if they are a nonresident alien receiving US-source income.

## Statutory framework: IRC § 1441 and 30% withholding

26 USC § 1441(a) requires that "all persons, in whatever capacity acting (including lessees or mortgagors of real or personal property, fiduciaries, employers, and all officers and employees of the United States) having the control, receipt, custody, disposal, or payment of any of the items of income specified in subsection (b) (to the extent that any of such items constitutes gross income from sources within the United States), of any nonresident alien individual or of any foreign partnership shall … deduct and withhold from such items a tax equal to 30 percent thereof."

The items of income subject to withholding include "interest (other than original issue discount), dividends, rent, salaries, wages, premiums, annuities, compensations, remunerations, and emoluments" and other fixed or determinable annual or periodical (FDAP) income (26 USC § 1441(b)). Payments to a nonresident alien independent contractor for services performed in the United States typically fall within "compensations" or "remunerations" and are therefore subject to 30% withholding unless an exception or treaty benefit applies.

The implementing regulation at 26 CFR § 1.1441-1(b)(1) provides that "a withholding agent must withhold 30 percent of any payment of an amount subject to withholding made to a payee that is a foreign person unless it can reliably associate the payment with documentation upon which it can rely to treat the payment as made to a payee that is a U.S. person or as made to a beneficial owner that is a foreign person entitled to a reduced rate of withholding."

The withholding agent must deposit the withheld tax and report the payment to the IRS and the payee on Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, by March 15 of the year following the payment, and file an annual Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, by March 15.

## Form W-8BEN: establishing foreign status and claiming treaty benefits

To avoid or reduce the 30% withholding, the nonresident alien contractor must provide the withholding agent with a valid Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals). The form serves two purposes:

1. Establishing foreign status. By completing Part I of Form W-8BEN (name, country of citizenship, permanent residence address, foreign taxpayer identification number if available, and US taxpayer identification number or ITIN if applicable), the contractor certifies under penalties of perjury that they are not a US person (not a US citizen or resident alien). This documentation allows the withholding agent to apply the rules of chapter 3 of the Internal Revenue Code (§§ 1441–1464) rather than the backup withholding regime that applies to US persons who fail to provide a Form W-9.

1. Claiming treaty benefits. If the contractor is a resident of a country with which the United States has an income tax treaty, they complete Part II (Claim of Tax Treaty Benefits) of Form W-8BEN to claim a reduced rate of withholding or an exemption on specific categories of income. On line 9, the contractor identifies the treaty country; on line 10, the contractor cites the specific treaty article and paragraph that grants the benefit, the type of income, and the applicable rate (often 0% for independent personal services or business profits not attributable to a US permanent establishment).

The IRS Instructions for Form W-8BEN (October 2021 revision) explain: "If you are claiming treaty benefits as a resident of a foreign country with which the United States has an income tax treaty for payments subject to withholding under chapter 3 or under section 1446(a) or (f), identify the country where you claim to be a resident for income tax treaty purposes." The form remains valid for the calendar year in which it is signed plus the next three calendar years, unless a change in circumstances makes any information on the form incorrect (in which case the contractor must provide an updated form within 30 days).

26 CFR § 1.1441-6 provides the regulatory framework for claiming treaty benefits. A withholding agent may rely on a valid Form W-8BEN to apply a reduced rate only if the form includes the contractor's US or foreign taxpayer identification number (TIN), except for certain payments on marketable securities, and the contractor certifies that they (a) are a resident of the treaty country, (b) derive the income within the meaning of IRC § 894 (the contractor is not fiscally transparent), and (c) meet any limitation-on-benefits provision in the treaty (many treaties deny benefits to third-country residents or entities whose ownership does not meet a minimum threshold of treaty-country residents).

## Categories of US-source income and treaty relief

The most common fact patterns for nonresident alien contractors engaged by US businesses are:

1. Compensation for services performed wholly outside the United States

IRC § 862(a)(3) provides that compensation for personal services performed outside the United States is foreign-source income and is not subject to US taxation unless it is effectively connected with a US trade or business. A nonresident alien contractor who performs all services remotely from their home country and does not enter the United States receives foreign-source compensation. The US payer has no withholding obligation under § 1441, and the contractor does not need to provide Form W-8BEN (though many US businesses request Form W-8BEN as documentation for their files and to avoid information-reporting confusion). The US payer does not file Form 1099-NEC (that form is for US persons only); if the payer files any form, it should be Form 1042-S reporting the payment with code 19 (compensation for independent personal services) and exempt income code 00 (foreign-source income, no withholding).

2. Compensation for independent personal services performed in the United States — treaty exemption under "business profits" or "independent personal services" articles

When a nonresident alien contractor performs services in the United States, the compensation is US-source income under IRC § 861(a)(3) and is subject to 30% withholding under § 1441 unless a treaty exemption applies. Most modern US income tax treaties (following the OECD Model Tax Convention) grant an exemption from US withholding on business profits of a treaty-country resident unless the resident has a permanent establishment in the United States. Older treaties include a separate article for independent personal services (often Article 14) that exempts the income unless the contractor has a fixed base in the US or is present in the US for more than 183 days in a 12-month period.

For example, a software developer who is a resident of the United Kingdom performs two weeks of onsite consulting services in California for a US client. Under Article 7 (Business Profits) of the US–UK Income Tax Treaty, the developer's fee is exempt from US tax unless the developer has a permanent establishment in the US. The developer provides Form W-8BEN citing Article 7 and claiming a 0% withholding rate; the US client does not withhold, and reports the payment on Form 1042-S with income code 19 and exemption code 04 (income exempt by treaty).

Important: The treaty exemption applies only if the contractor meets the residency and limitation-on-benefits tests in the treaty. The contractor must be a resident of the treaty country under the treaty's definition (typically the country where they are liable to tax by reason of domicile, residence, or similar criterion), and must satisfy any anti-treaty-shopping provisions. Many US treaties include a detailed limitation-on-benefits (LOB) article (typically Article 22 or 23) that denies treaty benefits unless the taxpayer qualifies under one of several enumerated categories (individuals are usually categorized as "qualified persons" if they are residents of the treaty country). The contractor must certify compliance with the LOB provisions on Form W-8BEN line 10 or by attaching a statement.

3. Noncompensatory income: interest, dividends, royalties

If the US business pays a nonresident alien contractor interest (for example, on a deferred-payment arrangement), dividends (if the contractor is also a shareholder), or royalties (for licensing intellectual property created by the contractor), those payments are US-source FDAP income subject to 30% withholding unless a treaty reduces the rate. Most US treaties reduce withholding on royalties to 0%–10% and on interest to 0%–15%, depending on the treaty and the type of interest or royalty. The contractor cites the applicable treaty article on Form W-8BEN line 10.

## Comparison to Form W-9 and Form 1099-NEC (US persons)

A US person (US citizen, resident alien, domestic corporation, or domestic partnership) engaged as an independent contractor provides Form W-9, Request for Taxpayer Identification Number and Certification, not Form W-8BEN. The US payer reports payments of $600 or more on Form 1099-NEC (box 1, Nonemployee Compensation) by January 31 of the following year. The payer does not withhold federal income tax unless the contractor is subject to backup withholding (24% on failure to provide a TIN or if the IRS notifies the payer that the contractor underreported income). The contractor self-reports the income on Schedule C and pays self-employment tax on Schedule SE.

A nonresident alien contractor receiving US-source income subject to § 1441 withholding does not receive Form 1099-NEC; instead, the withholding agent issues Form 1042-S and withholds at the 30% rate (or reduced treaty rate). The contractor files a US nonresident alien income tax return (Form 1040-NR) reporting the income and claiming a credit for the withheld tax. If the contractor claims a treaty exemption on Form W-8BEN and no withholding occurred, the contractor may still need to file Form 1040-NR if the income is otherwise subject to US tax or to claim a refund.

## Penalties and liability for failure to withhold

If a withholding agent fails to withhold the required 30% (or reduced treaty rate) and cannot later recover the tax from the payee, the withholding agent is liable for the tax, plus interest and penalties. IRC § 1461 provides that "every person required to deduct and withhold any tax under this chapter is hereby made liable for such tax." Penalties for failure to deposit withheld tax or to file Form 1042 can be substantial (up to 15% of the undeposited amount under IRC § 6656; penalties for failure to file Form 1042-S under IRC §§ 6721 and 6722 range from $50 to $290 per form, depending on the delay).

The withholding agent may rely on a valid Form W-8BEN to apply a reduced rate or exemption without further investigation, provided the withholding agent does not have actual knowledge or reason to know that the information is incorrect (26 CFR § 1.1441-7(b)). If the withholding agent has reason to know that a claim of treaty benefits is incorrect—for example, the contractor's permanent residence address on Form W-8BEN is in a different country from the claimed treaty country, or the contractor previously indicated US residence—the withholding agent may not rely on the form and must withhold at the statutory 30% rate.

## Cross-border employment considerations

For a foreign entity (for example, a UK limited company or a German GmbH) hiring a US-based worker, the analysis flips: the worker is likely a US person (citizen or resident alien) for whom the foreign entity has no § 1441 withholding obligation (that regime applies only to foreign persons receiving US-source income), but the foreign entity may have US employment tax obligations under the IRS common-law test if the worker is an employee, and the foreign entity may create a permanent establishment in the United States if the US-based worker habitually exercises authority to conclude contracts on behalf of the foreign entity, triggering US corporate income tax liability on profits attributable to the PE under the applicable tax treaty (typically implementing OECD Model Tax Convention Article 5(5), the dependent-agent PE rule). That analysis is outside the scope of this worker-classification guide; practitioners should consult the hiring-and-payroll-setup guide for the United States in the global-employment vertical.

Source: 26 USC § 1441 — Withholding of tax on nonresident aliens Source: 26 CFR § 1.1441-1 — Requirement for the deduction and withholding of tax on payments to foreign persons Source: 26 CFR § 1.1441-6 — Claim of reduced withholding under an income tax treaty Source: IRS Publication 515 (2026), Withholding of Tax on Nonresident Aliens and Foreign Entities Source: IRS Instructions for Form W-8BEN (October 2021) Source: IRS: Claiming tax treaty benefits

Many US states apply an ABC test to classify workers as employees or independent contractors under state wage-and-hour, unemployment insurance, and workers' compensation statutes. Unlike the federal IRS common-law test (which weighs the right to control as the central factor) or the FLSA economic reality test (which asks whether the worker is economically dependent on the employer), the ABC test creates a statutory presumption of employment and places the burden on the hiring entity to prove all three elements to establish independent contractor status. Failure to satisfy any one prong results in employee classification, triggering state minimum-wage, overtime, meal-and-rest-break, paid-sick-leave, unemployment insurance, workers' compensation, and withholding obligations.

The ABC test is significantly more restrictive than the federal tests. A worker may be classified as an independent contractor under the IRS common-law test or even the FLSA economic reality test yet still be deemed an employee under a state ABC test, exposing the hiring entity to back wages, penalties, and misclassification liability under state law.

## The three-prong ABC framework

Although the precise wording varies by state, the ABC test typically requires the hiring entity to prove:

(A) Freedom from control and direction. The worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of services and in fact. This prong resembles the federal common-law and economic reality tests' control inquiry, but many state courts interpret it more strictly: the hiring entity must lack control over both the result and the manner and means of the work.

(B) Work outside the usual course of business. The work performed is outside the usual course of the hiring entity's business or is performed outside all the places of business of the hiring entity. This prong has no federal analogue and is the most difficult hurdle for businesses whose core offering depends on the workers' services. For example, a delivery platform whose business is facilitating package delivery will struggle to demonstrate that its delivery drivers' work is "outside the usual course" of its business; a law firm engaging a plumber to repair office fixtures can more easily satisfy prong B because plumbing is not part of the law firm's usual course of business (legal services).

Some state formulations of prong B include an alternative: the work is performed either outside the usual course of business or outside all the places of business of the hiring entity. Under that disjunctive version, a worker who performs services entirely at their own location (not at any physical premises of the hiring entity) may satisfy prong B even if the work is within the usual course of business. However, California, Massachusetts, and New Jersey have eliminated or narrowly construed the "outside all places of business" alternative, making prong B conjunctive in practice: the work must be outside the usual course of business, and remote performance alone does not satisfy the test.

(C) Independently established trade, occupation, or business. The worker is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as the work performed for the hiring entity. This prong asks whether the worker operates a genuine independent enterprise—advertising services to the public, maintaining a business location, holding business licenses, serving multiple clients, and holding themself out as available for hire. A worker who performs services exclusively or primarily for one hiring entity and does not market their services or maintain a separate business typically fails prong C.

## Burden of proof and presumption of employment

The ABC test reverses the default: once the worker shows that they performed services for remuneration, the worker is presumed to be an employee, and the hiring entity bears the burden of proving—by a preponderance of the evidence—that all three prongs (A, B, and C) are satisfied. If the hiring entity fails to prove any single prong, the worker is an employee as a matter of law. This burden-shifting is the opposite of the federal IRS common-law framework, where classification turns on a totality-of-the-circumstances weighing with no statutory presumption.

## California: Labor Code §§ 2775–2787 (codifying Dynamex)

California applies the ABC test to most worker-classification questions under the California Labor Code, the Unemployment Insurance Code, and the wage orders of the Industrial Welfare Commission (IWC). The test was first adopted by the California Supreme Court in Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018), for purposes of IWC wage orders, and was codified and expanded by Assembly Bill 5 (AB 5), effective January 1, 2020 (originally codified at Labor Code § 2750.3, later recodified at §§ 2775–2787 by AB 2257 in September 2020).

California Labor Code § 2775 provides that "a person providing labor or services for remuneration shall be considered an employee rather than an independent contractor unless the hiring entity demonstrates" all three ABC prongs. The statute defines the prongs as follows:

• (A) The person is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact.
• (B) The person performs work that is outside the usual course of the hiring entity's business.
• (C) The person is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

California's formulation of prong B does not include the "outside all places of business" alternative. The work must be outside the usual course of business, period. The California Supreme Court in Dynamex explained that prong B "envisions that the hiring entity's 'usual course' of business refers only to the regular business activity that the hiring entity holds out to the public in its business operations, and not to the hiring of workers to perform incidental or ancillary tasks that are not part of the hiring entity's core operation."

Exemptions and industry carve-outs

California's ABC test includes numerous statutory exemptions for specified occupations and industries, codified at Labor Code §§ 2776–2783. When an exemption applies, the worker's status is determined under the Borello test (the common-law multi-factor control test from S.G. Borello & Sons, Inc. v. Department of Industrial Relations, 48 Cal.3d 341 (1989)) instead of the ABC test. Exemptions include, among others:

• Licensed insurance agents, physicians, dentists, psychologists, veterinarians, lawyers, architects, engineers, accountants, securities broker-dealers, real estate licensees, and certain other licensed professionals (subject to additional threshold requirements, such as maintaining a separate business location and setting their own rates).
• Bona fide business-to-business contracting relationships that satisfy a multi-part test (the business service provider must be a business entity, not a sole proprietor individual; must maintain a business location; must have a business license; must be able to set or negotiate rates; must be customarily engaged in the same type of work for other clients; and must exercise independent judgment).
• Construction industry subcontractors who hold a valid Contractors State License Board license and meet additional criteria under Labor Code § 2781 (formerly § 2750.5).
• Referral agencies (platforms that connect service providers with customers for graphic design, photography, tutoring, home cleaning, moving, dog walking, etc.) if ten enumerated conditions are satisfied.
• Musicians, content contributors, certain data aggregators, newspaper distributors, commercial fishers, and several other occupations specified in §§ 2779–2783.

Even when an exemption applies, the ABC test continues to govern for unemployment insurance purposes under the Unemployment Insurance Code, and the exemptions do not relieve the hiring entity of joint-employer or wage-theft liability under other California statutes.

Remedies for misclassification

Misclassified workers in California are entitled to the protections afforded to employees under the Labor Code and IWC wage orders, including minimum wage, overtime (time-and-one-half after 8 hours in a workday or 40 hours in a workweek, and double-time after 12 hours in a workday), meal and rest breaks, itemized wage statements, timely payment of wages on termination, paid sick leave, expense reimbursement, and unemployment and disability insurance coverage. A worker who proves misclassification may recover unpaid wages and statutory penalties under the Labor Code Private Attorneys General Act (PAGA), which authorizes civil penalties of $100 per employee per pay period for an initial violation and $200 per employee per pay period for subsequent violations (75% of recovered penalties go to the state, 25% to the aggrieved employees). The California Attorney General, district attorneys, and city attorneys may also bring enforcement actions seeking injunctive relief and civil penalties.

## Massachusetts: General Laws chapter 149, § 148B

Massachusetts enacted one of the first ABC tests in the United States in 1990 and has consistently applied it to wage-and-hour claims, unemployment insurance, and workers' compensation. The test is codified at Massachusetts General Laws chapter 149, section 148B.

M.G.L. c. 149, § 148B(a) provides that "an individual performing any service … shall be considered to be an employee under [chapters 149 and 151] unless" the hiring entity proves all three of the following:

• (1) The individual is free from control and direction in connection with the performance of the service, both under his contract for the performance of service and in fact; and
• (2) The service is performed outside the usual course of the business of the employer; and
• (3) The individual is customarily engaged in an independently established trade, occupation, profession, or business of the same nature as that involved in the service performed.

The Massachusetts test, like California's, does not include the "outside all places of business" alternative in prong 2 (the 2004 amendments to § 148B deleted that language). The Massachusetts Attorney General's 2008 Advisory on the law (Advisory 2008/1) states that for purposes of prong 2, the Office of the Attorney General "will consider whether the service the individual is performing is necessary to the business of the employing unit or merely incidental in determining whether the individual may be properly classified" as an independent contractor. If the work is necessary to the employer's business, the individual must be classified as an employee.

Penalties and enforcement

Misclassification under § 148B exposes the employer to criminal and civil penalties under M.G.L. c. 149, § 27C and to private civil actions under § 150. A misclassified employee may file a civil action and recover treble damages (three times the unpaid wages and benefits), attorneys' fees and costs, and statutory prejudgment interest at 12% per annum on the unpaid wages (not on the treble damages). Civil citations issued by the Massachusetts Attorney General's Fair Labor Division range from $7,500 to $25,000 per violation for first-time offenders, and a separate violation can occur for each pay period in which a worker is misclassified. Willful violations are punishable by criminal fines up to $25,000 and imprisonment up to one year for a first offense, and up to $50,000 and two years for subsequent offenses.

The Massachusetts Supreme Judicial Court has described the ABC test as "one of the strictest [independent contractor classification standards] in our country" and noted that California modeled its Dynamex rule on the Massachusetts statute. The Massachusetts test applies to wage and hour claims, unemployment compensation, and earned sick leave; it does not apply to workers' compensation classification (which uses a different test under M.G.L. c. 152) or to joint-employer determinations.

## New Jersey: Unemployment Compensation Law § 43:21-19(i)(6) and wage/hour extension

New Jersey has applied an ABC test for unemployment compensation purposes since 1936, codified at N.J. Stat. Ann. § 43:21-19(i)(6). The New Jersey Supreme Court extended the test to wage and hour claims in Hargrove v. Sleepy's LLC, 2015 N.J. LEXIS 38 (Jan. 14, 2015), holding that the ABC test governs whether a worker is an employee or independent contractor under the New Jersey Wage Payment Law and the New Jersey Wage and Hour Law.

The New Jersey ABC test (as applied to unemployment compensation and wage claims) requires the employer to prove:

• (A) The individual has been and will continue to be free from control or direction over the performance of the work, both under the contract of service and in fact; and
• (B) The work is either outside the usual course of the business for which such service is performed, or the work is performed outside of all the places of business of the enterprise for which such service is performed; and
• (C) The individual is customarily engaged in an independently established trade, occupation, profession, or business.

Unlike California and Massachusetts, New Jersey's prong B retains the disjunctive formulation: the employer can satisfy prong B by showing either that the work is outside the usual course of business or that it is performed outside all the employer's places of business. However, the New Jersey Supreme Court in Carpet Remnant Warehouse, Inc. v. New Jersey Department of Labor, 125 N.J. 567 (1991), interpreted "outside of all the places of business" narrowly: it "refers only to those locations where the enterprise has a physical plant or conducts an integral part of its business," not to any location where services happen to be rendered.

On May 5, 2026, the New Jersey Department of Labor and Workforce Development adopted final regulations at N.J.A.C. 12:11 interpreting the ABC test. The regulations synthesize decades of New Jersey Supreme Court case law (including Carpet Remnant Warehouse and East Bay Drywall, LLC v. Department of Labor, 251 N.J. 477 (2022)) and provide detailed guidance on each prong. The regulations apply to the New Jersey Unemployment Compensation Law, the New Jersey Wage and Hour Law, and the New Jersey Wage Payment Law, among other statutes, and become operative October 1, 2026. The regulations confirm that the burden of proof rests on the employer to establish all three prongs and that contractual labels (independent contractor agreements, issuance of Form 1099) carry no legal weight. The regulations also clarify that steps taken solely to comply with federal, state, or local law do not constitute "control" under prong A, and that a worker's home is not automatically part of the employer's "places of business" under prong B merely because the worker works remotely.

Penalties for misclassification in New Jersey include unemployment insurance contribution assessments, back wages and liquidated damages under the Wage Payment Law and Wage and Hour Law, stop-work orders, and civil penalties up to $250 per worker for a first violation and $1,000 per worker for a second violation, plus up to 5% of gross earnings per worker for the last 12 months of employment.

## Other states

Unable to confirm as of 2026-06-05.

## Cross-border employer takeaways

For a foreign entity engaging a US-based worker, the worker's classification under state law is often the first question. If the worker is located in California, Massachusetts, New Jersey, or another ABC-test state, the foreign entity must independently analyze the state ABC test even if the worker would be classified as an independent contractor under the federal IRS common-law test or the FLSA. Failure to satisfy all three ABC prongs may trigger:

• State income tax withholding, unemployment insurance contributions, and disability/family-leave insurance premiums in the worker's state.
• Liability for unpaid minimum wage, overtime, meal-and-rest-break premiums, and paid sick leave under state wage-and-hour law.
• Workers' compensation insurance coverage obligations (in many states, misclassified independent contractors are deemed employees for workers' compensation purposes).
• Permanent establishment (PE) risk if the US-based worker habitually exercises authority to conclude contracts on behalf of the foreign entity, triggering US federal and state income tax on profits attributable to the PE under the applicable tax treaty and state law.

Because state ABC tests presume employment and shift the burden to the hiring entity, cross-border employers should obtain local employment counsel's written analysis before classifying any US-based worker as an independent contractor in an ABC-test jurisdiction. Classification as an independent contractor under the IRS common-law test (for federal tax purposes) or under the home-country test does not provide safe harbor from state-law misclassification claims.

State ABC tests also do not preempt federal classification under the FLSA, Title VII, the National Labor Relations Act, ERISA, or other federal statutes; those statutes apply their own tests. A worker may simultaneously be an independent contractor under a state ABC test (if the employer satisfies all three prongs) yet still be an employee under the FLSA economic reality test, or vice versa. Employers must analyze each statute independently.

Source: Cal. Lab. Code § 2775 (California Legislative Information) Source: Dynamex Operations West, Inc. v. Superior Court, 4 Cal.5th 903 (2018) (California Supreme Court) Source: M.G.L. c. 149, § 148B (Massachusetts General Laws) Source: Massachusetts Attorney General Advisory 2008/1, Independent Contractor Law Source: Hargrove v. Sleepy's LLC, 2015 N.J. LEXIS 38 (N.J. Supreme Court, Jan. 14, 2015) Source: New Jersey Department of Labor: Independent contractors vs. employees