Businesses typically source labor through two primary channels: engaging independent contractors or hiring direct employees. Properly classifying workers as independent contractors versus employees is crucial for legal compliance, tax obligations, and avoiding significant penalties. See Contractor vs. Employee below for more information.
Compliance & Best Practices
Independent Contractor(s)
Compliance and Best Practices for Independent Contractors
- Verify Status: Use ABC Test, IRS Common Law Test, and Economic Realities Test guidelines to confirm true independent contractor status.
- Maintain Independence: Avoid setting hours, providing detailed instructions, or offering employee benefits to maintain independence.
- Insurance: Confirm contractors have their own insurance (liability, workers comp, etc.).
- Contracts: Have clear independent contractor agreements that are signed.
- Tax Forms: Collect Form W-9 before paying nonemployee compensation (independent contractors) and attorneys, if the total payments for tax year 2025 will be $600 or more, starting in 2026 will be $2,000 or more. Collect Form W-9 also for rents, prizes and awards, or other income payments for tax year 2025 will be $600 or more, starting in tax year 2026 that will be $2,000 or more.
- Reporting: If a deadline falls on a Saturday, Sunday, or Holiday it is due the next business day.
- Issue Form 1099-NECand Form 1099-MISC for payments of nonemployee compensation, attorneys, rents, prizes and awards, or other income payments paid to vendors in the amount of $600 or more for tax year 2025, and $2,000 or more for tax year being 2026 by January 31.
- Send 1099-NEC forms to the IRS and state agency if required by January 31st.
- Send 1099-MISC forms to the recipients by January 31.
- Send 1099-MISC forms to the IRS if filing by paper by February 28 and if filing electronically by March 31.
- Include Form 1096 Annual Summary and Transmittal when paper filing 1099 forms to the IRS.
- An aggregate of 10 or more forms (1099s, W-2, etc.) must be filed electronically.
- Check for State filing requirements. California is part of the IRS’s Combined Federal/State Filing (CF/SF) Program, meaning the IRS shares 1099 information with them electronically so usually there is not a separate requirement, while Oklahoma requires it for payments over $750.
- IRS Form 8655 must be approved before BAT Services can file Forms 1099 and 1096 for your business.
Employee(s)
Explore Compliance Standards and Best Practices for Each Stage of the Employee Management Cycle
- Poster/Posting Requirements
- Recruitment and Selection
- Onboarding New Hires
- Employee Management
- Employee Offboarding / Separation
Contractor vs. Employee
The government uses various tests (like the ABC Test, IRS Common Law, and Economic Realities Test to look beyond job titles to the actual working relationship. These guidelines help confirm a worker functions as a separate business entity, not as an employee. Always consult with a tax or legal professional for advice specific to your situation.
Understanding Federal and State Compliance Tests
“ABC TEST”
The State of California Department of Industrial Relations uses the “ABC Test” and starts with an assumption that all workers are employees and provides the test that a hiring entity must satisfy to prove that the workers are independent contractors.
Under the ABC test, a worker is considered an employee and not an independent contractor, unless the hiring entity satisfies all three of the following conditions:
- 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 the work and in fact;
- The worker performs work that is outside the usual course of the hiring entity’s business; and
- The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed.
Their website offers online reporting of labor law violations and wage claims.
“IRS Common Law Test”
The Internal Revenue Service uses the “IRS Common Law Test” which examines the degree of control and independence in the relationship using three categories:
- Behavioral control (what the worker does and how),
- Financial control (financial aspects like expenses and investment), and
- The relationship of the parties (how the relationship is perceived, including benefits or expected permanence).
Businesses can request an official IRS determination using Form SS-8.
“Economic Realities Test”
For FLSA compliance, the Department of Labor uses the “Economic Realities Test” is broader, assessing if a worker is “in business for themselves” or economically dependent on the employer. This test considers the totality of circumstances across factors like opportunity for profit or loss, investments, permanence of the relationship, employer control, the integral nature of the work to the business, and the worker’s skill and initiative. The Small Entity Compliance Guide published by the U.S. Department of Labor offers a detail overview of the final rules for determining employee or independent contractor classification, the six factors of “The Economic Reality Test”, common questions, and additional resources.