IRS Contractor vs. Employee Test: How to Classify Workers

Independent contractors have many benefits for organizations. They offer access to specialized skills on a flexible, project-based basis. Businesses can also use them to scale their workforce quickly and test new markets with fewer risks.

However, these advantages come with a critical risk: misclassifying workers as independent contractors when they legally qualify as employees.

In the US, employee misclassification can result in back taxes, fines, interest, and other retroactive damages for misclassified workers and their employers.

What makes this risk even greater is how easily the line between contractors and employees can blur in day-to-day operations, especially when they work side by side.

That is why the IRS contractor vs. employee test, also known as the 20-Factor Test, exists. It uses the common law test to decide if a worker is an employee for tax purposes, based on how much control the business has over their work and how independent the worker is.

The challenge is that the test isn’t always easy to apply. It weighs multiple factors that often overlap and require judgment based on context.

This is where Deel steps in. By using Deel Contractor and Deel Contractor of Record to hire, manage, and pay contractors, you remove the guesswork with automated worker classification and guidance from legal experts.

This article walks you through the IRS 20-Factor Test, its role in worker classification, and how to avoid misclassification with Deel.

Who is considered an independent contractor?

An independent contractor is a service provider who agrees with an employer to provide requested services on a need or project basis. They work independently and are not controlled by the employer in how they perform their tasks.

Independent contractors have a greater degree of control over how and when they carry out their work compared to employees. They typically cover their own business expenses unless the contract explicitly states otherwise, and are paid either a lump sum, an agreed-upon fee, or progress payments for their services.

Do labor laws apply to independent contractors?

While various labor laws govern the employer-employee relationship, they do not apply to independent contractors. Some of the things that don’t apply to an independent contractor include:

• Wage and hour law
• Benefits like a pension plan, insurance, vacation pay, and 13th salary
• Workers’ compensation
• Unemployment tax
• Social Security and Medicare

Independent contractors can receive bonuses as long as they do not imply a contractual relationship or compromise their independence.

The bonus terms should be clearly outlined in the contract. This includes specifying objective criteria for earning the bonus, such as completing a project ahead of schedule or meeting specific deliverables. Proper documentation acts as evidence that you are not treating the contractor as an employee.

It’s important to avoid bonuses tied to company-wide programs like performance reviews or company profits. They imply an employee relationship.

By using Deel to create your contractor agreements, we ensure your contracts capture the details of your bonuses accurately, reducing the risk of misclassification. Our in-house legal experts will review your bonus terms and alert you if there’s a risk of worker misclassification.

When it comes to tax withholding, you, as the client, are not obliged to withhold federal, state, and local taxes. Independent contractors are responsible for filing their own taxes.

However, you must file Form 1099-NEC if the total yearly payments to independent contractors (including prizes and awards) exceed USD 600.

See also: Form 1099-NEC vs. Form 1099-MISC: How to File Them in 2025

IRS relief options for worker misclassification

The IRS offers two options to help employers either correct past misclassification mistakes or safeguard themselves when a worker’s status is uncertain.

The Reasonable Basis test

The “Reasonable Basis” test offers protection for employers under Section 530 of the Revenue Act of 1978.

It prevents the IRS from challenging an individual’s status as an independent contractor. However, certain conditions have to be met that show you had a reasonable, good-faith basis for deciding the worker is an independent contractor.

If these conditions are met, you’ll have no tax liability for workers under Section 530, and the IRS cannot penalize you for misclassification.

These conditions are:

• You have always treated the worker as an independent contractor.
• You have filed all returns for the worker for all periods after 1978, and the independent contractor status was consistent.
• You had a reasonable basis for treating the individual as an independent contractor by either relying on:
  • Judicial precedent
  • Published rulings
  • A prior IRS audit showing no penalties assessed for similarly situated individuals
  • A longstanding recognized practice of a significant segment of the industry in which the individual worked

See also: Three Tests to Determine Worker Classification

Voluntary Classification Settlement Program (VCSP)

The VCSP serves employers who have misclassified workers but wish to correct the mistake without facing steep misclassification penalties.

This program allows eligible employers to reclassify independent contractors as employees and agree to prospectively treat their workers as employees moving forward.

In return, employers receive partial relief from federal employment taxes for eligible years of misclassification.

To participate, you must enter into a closing agreement with the IRS and meet specific eligibility requirements. You must:

• Have consistently treated the workers as independent contractors
• Have filed all required 1099 forms for the workers
• Not be under an employment tax audit by the IRS at the time of application
• Not be under a worker classification audit by the Department of Labor or a state government agency

To apply, you must submit IRS Form 8952 at least 120 days before you intend to reclassify workers as employees.

See also: Mastering Global Employment Status: A Guide to Worker Classification

What is the IRS 20-Factor test?

The IRS designed the 20-Factor Test to help organizations assess whether a worker is considered an employee or an independent contractor.

The factors fall into three main categories:

1. Behavioral control: Determines if the company controls or has the right to control what the worker does and how they do their job.
2. Financial control: Considers evidence of the financial and business aspects of the worker’s job, such as how they’re paid and whether the worker can realize a profit or incur a loss.
3. Relationship of the parties: Considers how the worker and the business perceive their relationship, including factors such as written contracts and the expectation of continued work.

No one factor is more important or indicative of employee status. It would be best if you looked at things holistically. If there are more "Yes" answers than "No," then there is a significant risk of employment relationship presence.

If you are unsure even after taking the test, we advise pursuing the IRS ruling. This is done by filing a Form SS-8 (Determination of Employee Work Status for Purposes of Federal Employment Taxes and Income Tax Withholding) with the IRS.

1. Instructions: Is the worker required to comply with the employer’s instructions about when, where, and how to work?
2. Training: Is training required? Does the worker receive training from or at the employer’s direction, including attending meetings and working with experienced employees?
3. Integration in business operation: Are the workers’ services integrated with the activities of the company? Does the success of the employer’s business significantly depend upon the performance of services that the worker provides?
4. Services rendered personally: Is the worker required to perform the work personally?
5. Authority to hire assistants: Does the worker have the option of hiring, supervising, and paying assistants for the employer? Does the company influence the hiring and payment of the workers’ assistants?
6. Continuing Relationship: Does the worker have a continuing relationship with the employer?
7. Set hours of work: Is the worker required to follow set hours of work?
8. Full-time work required: Does the worker work full-time for the employer?
9. Place of work: Does the worker perform work on the employer’s premises and use the company’s office equipment?
10. Sequence of Work: Does the worker perform work in a sequence set by the employer? Does the worker follow a set schedule?
11. Oral or written reports obligations: Does the worker submit regular written or oral reports to the employer?
12. Method of payment: How does the worker receive payments? Are there payments of regular amounts at set intervals?
13. Payment of business and travel expenses: Does the worker receive payment for business and travel expenses?
14. Furnishing of tools and materials: Does the worker rely on the employer for significant tools and materials?
15. Investment: Has the worker made a significant investment in the facilities or equipment used to perform services?
16. Realization of profit or loss: Is the payment made to the worker on a fixed basis regardless of profitability or loss?
17. Working for more than one company at a time: Does the worker only work for one employer at a time?
18. Availability of services to the general public: Are the services offered to the employer unavailable to the general public?
19. Right to discharge: Can the worker be fired by the employer?
20. Right to quit: Can the worker quit work at any time without liability?

Managing these factors can be overwhelming, but Deel makes it easy.

With Deel Contractor, you can manage and pay your contractors effortlessly. We provide automated workflows to create comprehensive contracts and contractor payroll. Our platform features built-in compliance features, including alerts for worker misclassification.

Alternatively, you can opt for the Deel Contractor of Record service, whereby Deel takes on the responsibility of compliantly hiring the contractor on your behalf. Deel becomes the official client of the contractor, handling all aspects of employment law, including worker classification and relevant tax filings. This means you can stop worrying about misclassification and focus on building your business.

In case you need any more reassurance, Deel’s Compliance Hub provides proactive compliance support to help you stay aligned with the latest worker classification rules.

This includes:

• Monthly Workforce Insights: Insights about your workforce and potential misclassification risks delivered to your inbox.
• Compliance Monitor: A comprehensive summary of your workforce’s compliance status and regulatory changes that may affect your workers’ classification and other legal requirements.
• AI-based Worker Classifier: An AI tool that automatically classifies workers based on local laws and IRS guidance.

Discover how Tiqets uses Deel to address misclassification and compliance challenges when hiring international contractors.

See also: How to Hire & Manage International Contractors in 2025

Classify workers accurately in 150+ countries with Deel Contractor of Record

Correct worker classification affects taxes, benefits, and risk exposure. If your company hires US or global contractors, Deel Contractor of Record helps you stay compliant and reduce misclassification risks.

It provides:

• Legally compliant contractor agreements and other locally required documents
• Automated worker classification based on local laws
• Automatic flagging of potential misclassification risks before they become issues
• Access to legal expertise to validate worker status when the risk is unclear
• Timely legal updates relevant to your workforce
• Accurate and timely contractor payments

As an all-in-one global people platform, Deel provides all the tools you need to hire, pay, and manage contractors and employees.

Book a demo to see it all in action.