United States Employee Misclassification: Risks & Best Practices

Hiring in the US offers incredible opportunities, but it also comes with a compliance challenge: employee misclassification. Federal regulators like the DOL and IRS, as well as strict states such as California and Massachusetts, closely examine whether contractors should really be classified as employees.

The consequences are steep: back wages, unpaid taxes, penalties, and costly settlements. The Biden administration’s 2024 gig worker rule makes it even more likely that long-term, regularly scheduled workers will be deemed employees.

This guide is for HR leaders, founders, and global hiring teams who need clarity on US classification rules, enforcement risks, and practical strategies to stay compliant. You’ll learn how regulators make decisions, what penalties to expect, and how an Employer of Record (EOR) can help you scale in the US with confidence.

What is employee misclassification?

Employee misclassification occurs when a worker is hired as an independent contractor but, under US law, should be classified as an employee.

Federal and state regulators have been increasingly strict, with the Department of Labor (DOL) and IRS leading enforcement. Misclassified workers may be entitled to overtime, benefits, and back taxes. Some states—including California and Massachusetts—have adopted especially tough rules, making compliance more complex for businesses operating across multiple jurisdictions.

The Biden administration’s gig worker rule (Jan 2024)

The new rule expands the likelihood that gig workers and contractors must be classified as employees.

What it means:

• If a worker is regularly scheduled (approx. 25+ hours per week) and working long-term (over 6 months), they are likely to be considered an employee
• Workers with defined schedules and close supervision are more likely to fall under employee status

Implications:

• Companies hiring non-corporate contractors in the US may need to convert them to employees or use an EOR arrangement
• Deel IC already applies strict standards, but clients engaging US contractors should carefully evaluate risk

Employee vs. contractor in the US: The basics

Courts and regulators apply a multi-factor test to assess classification, focusing on:

• Control: Does the employer dictate how, when, and where work is performed?
• Profit or loss: Can the worker realize profit or bear loss through their own managerial skills?
• Investment: Has the worker invested in their own tools or equipment?
• Permanency: Is the working relationship ongoing or project-based?
• Integration: Is the worker’s role integral to the employer’s core business?
• Independence: Is the worker in business for themselves, or economically dependent on the employer?

Indicators of employee status include:

• Employer control over work performance and scheduling
• The worker’s economic dependence on the employer
• Employer providing tools and equipment
• Worker not operating a separate business

State-specific rules:

• California & Massachusetts apply the ABC Test, which presumes workers are employees unless all three conditions are met:

  1. The worker is free from the control and direction of the hiring entity.
  2. The work performed is outside the usual course of the hiring entity’s business.
  3. The worker is engaged in an independently established business of the same nature.

See also: How To Determine Employment Status with Deel’s Worker Classifier

Risks of employee misclassification in the US

Employers face a wide range of consequences:

• Financial risks: Payment of back wages, overtime, benefits, and payroll taxes
• Legal risks: Penalties for violating the Fair Labor Standards Act (FLSA), state labor codes, and tax laws
• Business risks: Liability for workplace injuries, discrimination claims, and large-scale lawsuits
• Reputational risks: Public settlements and lawsuits can damage brand trust and recruitment

See also: How to Hire and Pay International Contractors Legally

Employee misclassification penalties in the US

If contractors are reclassified as employees, employers may be liable for:

• Back wages, overtime, and employee benefits
• Employment taxes, unemployment insurance, and workers’ compensation contributions
• Civil fines and penalties under federal and state labor laws
• Class-action settlements that reach tens or even hundreds of millions of dollars

Key cases demonstrate the scale of liability:

• 2023: A baked goods producer paid $55M to settle misclassification claims.
• 2021: An oil and gas firm paid $43M in back wages to 700 misclassified workers.
• 2017: FedEx reached a $227M settlement covering 12,627 drivers across states.
• 2015: FedEx paid $228M to settle another driver misclassification lawsuit.
• 2000: Microsoft settled for $97M with 8,000–12,000 misclassified workers.

These cases show how misclassification disputes can become high-cost, high-profile legal battles. For that reason, many companies have expanded using an EOR model to ensure compliance.

See also: Employee Misclassification Penalties: Examples and Protections

Best practices to avoid misclassification

Employers in the US should take proactive steps to minimize risk:

• Review contracts and ensure they reflect the true working relationship
• Train HR and managers on federal and state classification rules
• Conduct compliance audits of contractor arrangements
• Use Deel’s Worker Classifier to assess status risk
• Consider Employer of Record hiring for high-risk roles or long-term engagements

See also: How to Hire Using an Employer of Record in the US (2025)

Employer of Record hiring in the US

For businesses that want to eliminate misclassification risk, using an EOR is the safest choice.

With Deel EOR in the US:

• Deel acts as the legal Employer of Record
• We handle payroll, taxes, benefits, and compliance with federal and state laws
• You manage daily responsibilities while staying compliant

This allows you to hire quickly without worrying about navigating complex US employment law variations.

See also: What Is an Employer of Record (EOR)? A Complete Guide

Signs of misclassification

Your contractor arrangements in the US may be risky if:

• Contractors work on long-term, ongoing roles
• They follow set schedules or work under close supervision
• Their work is central to your business operations
• They lack a separate business entity and use your tools or systems

Spotting these signs early can help avoid disputes and lawsuits.

See also: How to Convert a Contractor to an Employee Fast and Seamlessly

Prevent employee misclassification in the US

To safeguard your business:

• Conduct routine internal audits of worker arrangements
• Seek legal reviews for state-specific contractor engagements
• Use Deel’s classification support to identify risk
• Transition contractors to EOR hiring when necessary

By embedding compliance into workforce planning, you reduce legal, financial, and reputational risks while keeping hiring flexible.

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

Hire US talent compliantly with Deel EOR

In the US, worker misclassification carries state-by-state complexity, rising federal enforcement, and high financial liability. Employers who misclassify face back pay, lawsuits, and multi-million-dollar settlements.

With Deel EOR, you can:

• Hire US employees without setting up an entity in every state
• Stay compliant with federal and state labor laws
• Minimize the risk of misclassification disputes and penalties

Book a demo to see how Deel helps you compliantly hire and manage US talent.