Employee or Independent Contractor? The 2026 DOL Test Business Owners Should Know

It is one of the most common questions we get from business owners: "Can I just pay this person as a 1099?" The honest answer is that the business does not simply get to choose. Issuing a Form 1099, collecting a Form W-9, asking the worker to form an LLC, or signing an independent-contractor agreement does not by itself establish that the worker is legally an independent contractor. Classification turns on the substance of the working relationship, and the federal framework for evaluating that relationship is in the middle of a significant change in 2026.

Last reviewed: September 1, 2026. Federal worker-classification guidance is actively changing, so check the sources at the end of this article for the current status before relying on any single statement here.

Paperwork Does Not Decide Classification

Under the federal Fair Labor Standards Act (FLSA), whether a worker is an employee or an independent contractor is decided using an "economic reality" analysis. The question the Department of Labor asks is whether, as a matter of economic reality, the worker is in business for themselves or is economically dependent on the business for work.

That means documents describe the arrangement; they do not create it. A contract can be strong evidence of what the parties intended, but if the day-to-day relationship looks like employment, the paperwork will not carry the analysis on its own.

The Six Factors Business Owners Should Understand

The Department of Labor's 2024 independent contractor rule (29 CFR Part 795, effective March 11, 2024) sets out six economic-reality factors, weighed together as a totality of the circumstances, with no single factor given predetermined weight. Even with the 2026 rulemaking underway (more on that below), these six factors are the clearest plain-English checklist a business owner can use.

1. Opportunity for Profit or Loss Depending on Managerial Skill

Can the worker make more — or lose money — based on their own business decisions? Setting prices, bidding jobs, deciding which work to accept, managing costs, and marketing to new customers all point toward an independent business.

Example: a worker paid a flat hourly rate whose only way to earn more is to work more hours looks more like an employee. A contractor who quotes a fixed project price and keeps the upside if they finish efficiently — and eats the cost if they do not — looks more like an independent business.

2. Investments by the Worker and the Business

Does the worker make capital or entrepreneurial investments that support an independent business — equipment, software licenses, vehicles, insurance, advertising? Buying a tool for one specific job is not the same as investing in a business.

Example: a worker who uses the company's computer, company software logins, and company workspace looks more like an employee. A consultant who carries their own liability insurance, licenses their own software, and invests in equipment they use across many clients looks more like a business.

3. Degree of Permanence of the Relationship

Is the work indefinite, continuous, and exclusive — or is it project-based, defined, and non-exclusive?

Example: an open-ended arrangement with no end date and steady weekly hours leans employee. A defined engagement with a scope, a deliverable, and an end date — repeated across several clients — leans contractor.

4. Nature and Degree of Control

Who controls the work? This covers scheduling, supervision, setting the methods and sequence of the work, requiring specific procedures, restricting the worker from taking other clients, and using performance management or discipline.

Example: assigning a schedule, training the worker on your process, and reviewing their work as it is performed leans strongly toward employment. Agreeing on an outcome and a deadline while the worker decides how and when to get there leans toward a contractor relationship.

5. Whether the Work Is Integral to the Business

Is the work the business's core product or service, or is it a support function outside the main line of business?

Example: bookkeepers doing client bookkeeping at an accounting firm are performing the firm's core service — that leans employee. A firm engaging an outside web developer to rebuild its website is buying something outside its core service.

6. Skill and Initiative

Does the worker use specialized skill together with business initiative? Skill alone is not enough — highly skilled employees exist everywhere. The question is whether the worker uses that skill in connection with running their own business.

Example: a skilled technician who is trained and directed by the business leans employee. A specialist who markets that expertise independently, competes for work, and decides how to deploy it leans contractor.

What's Changing in 2026?

This is the timely part, and it is worth reading carefully because there is a real difference between what is on the books, what the government is actually enforcing, and what has only been proposed.

What Is Currently On The Books

The Department of Labor's 2024 independent contractor rule (89 FR 1638) took effect March 11, 2024 and remains codified at 29 CFR Part 795. It has not been vacated nationwide by a court. That is the six-factor, totality-of-the-circumstances framework described above.

What The DOL Is Actually Enforcing

In Field Assistance Bulletin No. 2025-1 (May 1, 2025), the Wage and Hour Division instructed its investigators not to apply the 2024 rule in enforcement matters while the rule is under review, and to rely instead on earlier sub-regulatory guidance — including Fact Sheet #13 and a 2019 opinion letter. Importantly, that bulletin is internal enforcement guidance. It does not repeal the 2024 rule, and it does not bind courts hearing private FLSA lawsuits, which continue to apply judicial economic-reality tests.

What Has Only Been Proposed

On February 26, 2026, the Department announced a Notice of Proposed Rulemaking, published in the Federal Register on February 27, 2026 (91 FR 9932, RIN 1235-AA46, docket WHD-2026-0001), that would rescind the 2024 rule and largely restore the framework from the 2021 independent contractor rule. As of this article's review date, this is a proposal. It is not final law, and businesses should not classify workers on the assumption that it will take effect in any particular form.

The proposed framework uses five factors rather than six, and — this is the substantive change business owners should note — it does not weigh all factors equally. Two are designated "core" factors carrying greater weight:

• Core factor: the nature and degree of control over the work
• Core factor: the worker's opportunity for profit or loss
• The amount of skill required for the work
• The degree of permanence of the working relationship
• Whether the work is part of an integrated unit of production

In practice, if the proposal were finalized as written, control and opportunity for profit or loss would drive most classification outcomes, and the remaining factors would matter mainly when the two core factors point in different directions. Until a final rule is published, the sensible planning posture is to be able to support your classification under both frameworks — which, in most real fact patterns, means paying close attention to control and to whether the worker genuinely runs their own business.

Employee vs. Independent Contractor: Practical Warning Signs

Two Examples

Example 1 — Likely Employee Characteristics

A bookkeeping company hires a worker for roughly 30 hours every week. The firm assigns the clients, decides when the work needs to be performed, trains the worker on its processes, supervises the work, pays an hourly rate, and expects the relationship to continue indefinitely.

Issuing that person a Form 1099 would not, by itself, make them an independent contractor. Nearly every factor points the same direction: the business controls the schedule and the method, the worker has no meaningful opportunity for profit or loss beyond hours worked, the relationship is indefinite, and the work is the firm's core service. The 1099 describes how the payment was reported — it says almost nothing about the underlying relationship.

Example 2 — Stronger Independent-Contractor Characteristics

The same company engages an IT consultant to migrate its systems. The consultant operates their own business, works for multiple customers, sets their own pricing, determines how the project will be completed, uses their own equipment, can bring in help, and bears the economic risk of finishing efficiently.

This relationship has substantially stronger independent-business characteristics: control over method sits with the consultant, there is real opportunity for profit or loss based on managerial skill, the engagement is project-scoped, the consultant has made business investments, and the work is outside the firm's core service. That is a materially different fact pattern from the first example — though classification in any real case depends on the complete facts, not a summary like this one.

New York Businesses: The Federal Test Isn't the Whole Story

Worker classification is not decided once for all purposes. Different laws and different agencies apply different standards, and a conclusion under the federal FLSA does not automatically carry over.

For New York employers, unemployment insurance coverage is generally evaluated under a common-law analysis focused on supervision, direction, and control, as administered by the New York State Department of Labor. Workers' compensation coverage, state wage-payment obligations, and tax withholding can each be evaluated under their own rules. A worker treated as a contractor for one purpose may still be covered for another.

This article does not attempt an exhaustive New York legal analysis. The practical point is that New York employers should review classification carefully — and specifically consider unemployment insurance and workers' compensation exposure — before deciding to treat a worker as an independent contractor.

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"But My Worker..."

Each of the following comes up regularly. None of them, standing alone, settles the classification question.

• "They asked me to pay them as a 1099." Worker preference does not change the economic reality of the relationship, and classification protections generally cannot be waived by agreement.
• "They signed an independent-contractor agreement." A contract is evidence of intent, but the actual working relationship controls the analysis.
• "They gave me a W-9." A W-9 collects a taxpayer identification number for information reporting. It is a reporting document, not a classification determination.
• "They have an LLC." Entity formation is easy and says little about control, economic dependence, or whether the worker operates a real independent business.
• "They work from home." Remote work is common for employees. Where the work happens matters far less than who directs it.
• "They only work part-time." Part-time employees are employees. Hours affect payroll math, not classification.
• "They have another job." Working elsewhere is one data point about economic dependence, but many employees hold second jobs.
• "I don't provide benefits." Benefits are largely an employer choice. Declining to offer them does not convert an employee into a contractor.

What Happens If a Worker Is Misclassified

Misclassification is usually discovered in one of three ways: a worker files for unemployment, a worker files a wage claim, or an agency audit picks it up. The consequences are generally financial and administrative rather than dramatic, but they compound over time:

• Unpaid payroll taxes, including the employer share of Social Security and Medicare, plus federal and state unemployment tax
• Wage and hour exposure, including minimum wage and unpaid overtime claims
• Unemployment insurance assessments and experience-rating consequences
• Workers' compensation coverage gaps and related penalties
• Penalties and interest, which accrue from the original due dates
• Amended payroll filings and corrected information returns across affected quarters and years
• Additional scrutiny from state and federal agencies, since one agency's finding often prompts review by another

The practical takeaway is timing: correcting a classification going forward is a manageable payroll project. Reconstructing several years of payroll after a notice arrives is not.

Not Sure Whether Someone Belongs on Payroll?

Worker classification is far easier to address before the first payment than after a government notice arrives. If you are hiring and are not sure whether the relationship should be W-2 or 1099, Evening Star can help you review the accounting and payroll implications and set up the appropriate payroll process — including onboarding, withholding, and filings.

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This article provides general educational information and is not legal or tax advice. Worker classification is highly fact-specific and may be governed by different federal and state standards. Businesses should consult appropriate legal, tax, payroll, or employment professionals regarding their specific circumstances.

The information provided is for general educational purposes and should not be considered individualized tax, accounting, legal, or financial advice. Tax rules and reporting requirements depend upon individual circumstances. Please consult with an appropriate professional regarding your specific situation.