How do you hire contractors in the United States in 2026?

The practical difference shows up in three places: who carries the payroll tax, who carries the employment risk, and who controls the work day to day.

The classification matters because the IRS, the DOL, the state revenue department, and the state labour department can each look at the same arrangement and reach different answers. The federal common-law test is the baseline. The states layer their own tests for income tax, unemployment insurance, wage-and-hour protection, and worker’s compensation eligibility. Run the Contractor Classifier on every engagement before you sign.

The three categories work together: each pushes the engagement toward either employment or self-employment, and the IRS weighs the whole picture. The test is documented in IRS Publication 15-A and at IRS Topic 762.

1. Behavioural control

Does the business have the right to direct and control how the worker does the work, even if it doesn’t actually exercise that right? Key signals: detailed instructions about when, where, and how to work; required training; required attendance at meetings; required tools or systems. Strong behavioural control points to employment.

2. Financial control

Does the worker have a meaningful financial stake in the work? Signals: investment in equipment, the ability to make a profit or take a loss on the engagement, services advertised to the wider market, payment by the job rather than the hour, the right to send a substitute, unreimbursed business expenses. Strong financial autonomy points to self-employment.

3. Relationship of the parties

Does the worker look like part of the organisation? Signals: a written contract that genuinely reflects the working pattern, no employee benefits, services that are not a core part of the regular business, a defined engagement with a clear end date. A long, open-ended engagement that delivers core business services points to employment.

If the test fails: Form SS-8

Either you or the worker can file Form SS-8 (Determination of Worker Status) and ask the IRS to issue a binding classification determination. The IRS typically takes six months to respond. The determination is binding for federal tax purposes but doesn’t bind state authorities or the DOL.

The 2024 DOL economic reality test

For wage-and-hour purposes (overtime, minimum wage), the DOL’s Final Rule effective 11 March 2024 restored the multi-factor economic reality test. The DOL looks at six factors: opportunity for profit or loss, investment in the work, permanence of the relationship, nature and degree of control, work integral to the business, and skill and initiative. The DOL test runs alongside the IRS test, not in place of it. A worker can be a contractor under one and an employee under the other.

The ABC test asks three questions, all of which must be answered “yes” for the worker to be a contractor:

• A. The worker is free from the company’s control and direction in performing the work, both under contract and in practice.
• B. The work is outside the usual course of the company’s business.
• C. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed.

The B prong is the trap. A marketing agency engaging a freelance copywriter usually fails B in California, because copywriting is part of the agency’s usual course of business. The same engagement would pass the IRS three-category test.

California: AB5 and the Dynamex strict ABC test

California adopted the ABC test for wage-order purposes in the 2018 Dynamex decision and codified it for most state employment purposes in Assembly Bill 5 (AB5), effective 1 January 2020. AB5 has been amended several times since, adding statutory exemptions for specific occupations (licensed professionals, real estate agents, construction subcontractors meeting AB2257 criteria, business-to-business contractors meeting 12 specific tests). Check the current exemption list in the primary statute before classifying.

Massachusetts: the strictest ABC test in the country

Under M.G.L. c. 149, § 148B, Massachusetts applies the ABC test for all employment purposes, with no statutory exemption analogous to California’s. Massachusetts courts read the B prong more strictly than California, demanding the work be outside the usual course of the employer’s business even for short engagements.

New Jersey, Illinois, and the unemployment-only states

New Jersey applies the ABC test under N.J.S.A. 43:21-19(i)(6) for state UI and wage-payment purposes. Illinois applies it for the Illinois Wage Payment and Collection Act. Around 25 other states apply the ABC test only for state unemployment insurance eligibility, not for income tax withholding. That split matters: a worker can be a contractor for federal income tax and a state-UI-purposes employee at the same time.

New York Freelance Isn’t Free Act (statewide, August 2024)

New York’s Freelance Isn’t Free Act took effect statewide on 28 August 2024 under NY Labor Law § 191-d. It doesn’t change the classification test. It requires a written contract for any freelance engagement of $800 or more, mandates payment within 30 days of work completion or by the contracted date, and provides double damages plus attorney’s fees for non-payment. The Act applies to genuine freelancers; misclassified employees still recover under wage-and-hour law.

Stack the federal cost on a single misclassified worker paid $80,000 over three years:

The 100 percent wilful penalty applies when the IRS finds the misclassification was intentional, not when it was an honest error. For honest errors, Section 3509 reduced rates apply and the federal exposure drops to roughly 10.7 percent of wages paid plus 1.5 percent for the unwithheld income tax (rather than the full 24 percent open-market rate).

Who chases the back tax

The IRS opens employment-tax audits through three doors: a worker files Form SS-8 asking for a determination; a worker files a Schedule SE then later switches to claiming employee status (Form 8919); or a routine 941 audit looks at 1099 spend in the prior three years. State revenue and labour authorities run parallel audits. California’s EDD audits trigger automatically when a 1099 contractor files for unemployment.

The three-year lookback

The federal statute of limitations under IRC Section 6501 runs three years from the return filing date. There is no statute of limitations for fraudulent or wilfully unfiled returns. Practical impact: most enforcement actions reach back three years and stack penalties across all misclassified workers in that window.

Section 530 is the most-litigated provision in employment-tax practice. The IRS audit manual treats it as a threshold defence: the auditor must apply Section 530 first, before reclassifying.

The three conditions, all of which must be met

1. Reasonable basis. You had a reasonable basis for treating the worker as a contractor. The safe-harbor categories of reasonable basis are: a prior IRS audit that did not reclassify the same role; a published court case or IRS ruling supporting the classification; a long-standing recognised industry practice (sometimes interpreted as 10 years or more, though courts vary); or any other reasonable basis the employer can document.
2. Consistent treatment. You treated all workers in substantially similar positions as contractors. If you classified some as employees and others as contractors for the same role, Section 530 fails.
3. Filing consistency. You filed all required Forms 1099-NEC (or 1099-MISC pre-2020) on time for every contractor in the role for the years in question. A missed 1099 invalidates Section 530 for that worker.

What Section 530 does and doesn’t do

If Section 530 applies, the employer keeps treating the worker as a contractor going forward, with no back tax, no penalty. The relief is prospective: the underpaid federal tax for the audit period is forgiven (the IRS doesn’t collect it). The relief is federal only. State revenue and labour authorities (especially California, Massachusetts, New York) routinely ignore Section 530 and pursue their own back tax and penalties. Section 530 also does not protect against FLSA wage-and-hour claims, which are administered by the DOL on the economic reality test.

The voluntary classification settlement program (VCSP)

If Section 530 doesn’t apply, the IRS offers the Voluntary Classification Settlement Program as an alternative. Under VCSP, the employer voluntarily reclassifies the workers going forward, pays 10 percent of the federal employment tax that would have been due on the most recent year (a sharp reduction from the open-market Section 3509 cost), and gets immunity from federal back tax and interest. VCSP requires the employer to be under no current IRS audit on the classification issue. Most employers use VCSP only when Section 530 is clearly unavailable, because VCSP triggers a forward W-2 commitment and the state-tax exposure remains separate.

The reasoning mirrors the UK IR35 logic. Worker classification asks whether the working arrangement looks like employment. If you move a contractor onto an EOR, the working arrangement becomes employment: same role, same client, same hours, just routed through a different legal employer. The IRS view: the arrangement was already employment, you just made it explicit.

The federal lookback for unfiled employment-tax returns is three years under IRC Section 6501, indefinite for wilful underfiling. Moving someone to an EOR doesn’t prevent the IRS from opening an audit on the prior three years of 1099 engagement.

When EOR is the right answer for an at-risk engagement

If the engagement is honestly assessed as employment from day one, the worker is a disguised employee, and the client wants to engage them as such, EOR is one of three legitimate paths:

1. Direct W-2 employment via your own US entity (Teamed US Inc., your own US sub, or a PEO that runs payroll on your FEIN).
2. EOR engagement via Teamed US Inc. as the legal employer. Teamed runs the W-2, FICA, federal and state withholding, benefits enrolment, and state UI registration.
3. 1099 continuation with prospective reclassification via the IRS Voluntary Classification Settlement Program. Available only if no current IRS audit on the issue and the employer accepts the 10 percent prior-year settlement and forward W-2 conversion.

EOR is the cleanest answer for sub-12-month engagements, multi-state remote teams, or when you don’t want to add to your own US entity’s payroll. EOR via Teamed US Inc. is in-scope under our single $599 per employee per month fixed rate; statutory employer cost passes through at cost. See Zero FX pricing.

What EOR is not

EOR is not retroactive misclassification cover. Moving a contractor onto an EOR on 1 June does not cure the prior 18 months of 1099 treatment. For that, you need Section 530, VCSP, or to accept the federal back tax under Section 3509.

The operational onboarding sequence:

1. Run the classification test before signing. IRS three-category common-law test plus the state ABC test if the contractor is resident in or working from California, Massachusetts, New Jersey, Illinois, Washington, or any other ABC-test state. Run the Contractor Classifier on every engagement.
2. Collect Form W-9. The contractor completes Form W-9 providing their legal name, business name if different, taxpayer identification number (SSN or EIN), and address. Keep the form on file for four years.
3. Sign a written contract documenting independence. Scope of work, fixed deliverables or output-based pricing, no required hours, no required tools, no required location, no exclusivity, right to send a substitute, right to take on other clients. A vague contract documenting hourly work and required attendance is misclassification evidence on its own.
4. Pay against invoices, not payroll. The contractor invoices you. You pay in full, gross, no withholding (except backup withholding at 24 percent if the contractor refuses to provide a TIN). Pay through accounts payable, not payroll, to keep the audit trail clean.
5. File Form 1099-NEC by 31 January. For any contractor paid $600 or more in aggregate in the calendar year. File Copy A with the IRS by 31 January; provide Copy B to the contractor by 31 January. The threshold is per contractor, not per engagement; $300 paid to one contractor across two engagements adds up to $600 and triggers the form. Some states have lower thresholds.
6. Track multi-state nexus. Paying a contractor based in a state where you have no other footprint can trigger nexus for state income tax or business registration. Run a nexus check before paying a contractor in any state where you have no other operations.

Backup withholding (the 24 percent trap)

If a contractor refuses to provide a W-9, provides an obviously wrong TIN, or the IRS notifies you that a TIN you used is incorrect (CP2100 notice), you must withhold federal tax at 24 percent of every payment to that contractor until the TIN issue is resolved. Backup withholding is reported on Form 945 annually. Practical rule: never make the first payment without the W-9 in hand.

Multi-state pay

A US contractor pays their own federal and state income tax. You don’t withhold. But state nexus can trigger your own tax registration in the contractor’s state if their work creates business presence there. The risk is highest for sales-tax-relevant work, in-state physical presence, or any state with economic-nexus rules at low thresholds. Run the nexus check at engagement, not at year-end.

Teamed Guard: keep the engagement, add the cover

Use Guard when the contractor relationship is genuinely outside W-2 in your honest assessment, you want to keep the direct commercial relationship with the contractor (often because they prefer it), and you want quarterly independent review plus a defined liability cap if the IRS, the DOL, or a state authority challenges. Guard sits over the top of your existing 1099-NEC arrangement: the contractor invoices you, you pay them, and Teamed runs the classification review on the cadence.

Teamed Protect: transfer the engagement, transfer the risk

Use Protect when you want full liability transfer to Teamed. Mechanically: Teamed engages the contractor under our agreement, the contractor delivers the work to you, and Teamed carries the misclassification risk in full. You get the work; Teamed holds the contractor relationship and the audit-trail position. This is the right answer for high-stakes engagements where the cost of a misclassification finding would be material to the business, or for any engagement in California, Massachusetts, or New Jersey where the ABC test creates added exposure.

The other two engagement models

Beyond Guard and Protect, Teamed supports two further models for engagements that are genuinely employment in substance:

• EOR employment via Teamed US Inc. as the legal W-2 employer, for relationships that are employment dressed up as contracting. Switch the worker to direct employment via our EOR and the classification question disappears. Same $599 per employee per month fixed rate as every other Teamed EOR country.
• The Graduation Model, for converting US contractors to W-2 employees on your own US entity once you’ve reached the volume crossover. Continuous service preserved. Most US clients graduate to their own entity between 18 and 30 employees, where the entity-management cost stops being heavier than the EOR fixed rate. Run the EOR vs Entity Crossover Calculator to find your number.

Teamed’s view on contractor classification: it’s a tax-status question, not a contractual-magic question. If the working arrangement looks like employment, structure it as employment via EOR. If it’s genuinely external, use Guard or Protect to back the position. Don’t buy synthetic 1099 status through clever contracting. The IRS looks through it.