Quick answer: Whether a worker is an employee or an independent contractor depends on the actual working relationship, not on what you call it or what the contract says. The IRS looks at behavioral control, financial control, and the relationship of the parties; New York applies its own tests for unemployment insurance and workers' compensation, and some industries face a presumption of employment. If you control how, when, and where the work is done, the worker is probably an employee.
Paying someone as a contractor is simpler and cheaper on the surface. No withholding, no unemployment insurance, no workers' compensation premium. That is exactly why worker classification gets so much attention from the IRS and the New York State Department of Labor. Getting it wrong can mean back taxes, penalties, and interest, sometimes years after the fact.
Why classification matters
When a worker is an employee, the business must withhold income tax, pay the employer's share of Social Security and Medicare, pay federal and state unemployment tax, and in New York carry workers' compensation, disability, and paid family leave coverage. Employees are also covered by minimum wage and overtime laws.
When a worker is a true independent contractor, none of that applies. The contractor pays self-employment tax and handles their own insurance, and you may need to issue a Form 1099-NEC. The difference in cost is real, which is why the agencies look past labels.
How does the IRS decide?
The IRS uses the common law rules, which it groups into three categories. No single factor decides the case; the IRS looks at the whole relationship. Its page on independent contractor or employee is a good starting point.
Behavioral control. Does the business control or have the right to control what the worker does and how?
- Detailed instructions about when, where, and how to work
- Required training in the company's methods
- Evaluation based on how the work is done, not just the result
Financial control. Does the business control the economic side of the job?
- Who supplies tools, equipment, and materials
- Whether the worker can make a profit or suffer a loss
- Whether the worker offers services to the public and has other clients
- How the worker is paid: by the hour or week, or by the project
Relationship of the parties. How do the parties see the arrangement?
- Written contracts (helpful but not decisive)
- Benefits such as insurance, vacation, or retirement plans
- Whether the relationship is expected to continue indefinitely
- Whether the work is a key part of the regular business
New York has its own tests
New York agencies do not simply follow the IRS. The Department of Labor applies its own analysis for unemployment insurance, focused heavily on control. The Workers' Compensation Board has its own standards too. A worker can be treated as an employee for state purposes even if you have a reasonable argument under federal rules.
Some industries carry extra risk:
- Construction. New York's Construction Industry Fair Play Act presumes that workers in construction are employees unless the business can show they meet specific tests for independence or a separate business entity.
- Commercial goods transportation. A similar presumption applies to certain commercial drivers under the state's Commercial Goods Transportation Industry Fair Play Act.
Employers in Central New York's building trades should take these rules seriously. A single unemployment claim from a former "contractor" can trigger an audit covering every similar worker. The New York State Department of Labor publishes guidance on both laws.
What happens if you get it wrong?
Misclassification can lead to:
- Back payroll taxes, including the employer share of Social Security and Medicare.
- Liability for income tax you should have withheld, in some cases.
- Unpaid unemployment insurance contributions and workers' compensation premiums.
- Penalties and interest at both the federal and state level.
- Wage claims for unpaid overtime.
In some situations, the IRS offers relief for businesses that had a reasonable basis for their treatment, and a Voluntary Classification Settlement Program lets eligible businesses reclassify workers going forward with reduced liability. These are worth discussing with an advisor before an agency comes to you.
How to protect your business
A few practical steps reduce your risk considerably:
- Look at the reality, not the paperwork. If you set the schedule, train the person, and supply the tools, a contract will not save you.
- Get a W-9 and evidence of an independent business. A business name, other clients, their own insurance, and their own equipment all help.
- Pay by the project when it fits the work, rather than by the hour on a weekly schedule.
- Do not convert an employee to a contractor doing the same job. That is one of the clearest red flags.
- When in doubt, ask. Form SS-8 lets you or the worker request an IRS determination, though it takes time.
Once a worker is properly classified as an employee, you will need payroll in place. Our article on setting up payroll for your first employee in New York walks through it, and our bookkeeping and payroll services can run it for you.
Frequently asked questions
Can I make someone a contractor just by having them sign a contract?
No. A contract helps show the parties' intent, but the IRS and New York look at how the relationship actually works. If you control the work like an employer, the worker is likely an employee regardless of the paperwork.
Can a worker be a contractor for the IRS and an employee for New York?
It is possible. New York applies its own tests for unemployment insurance and workers' compensation, and certain industries such as construction face a presumption of employment under state law. Classification should be checked under both sets of rules.
What is Form SS-8?
Form SS-8 asks the IRS to determine whether a worker is an employee or an independent contractor for federal tax purposes. Either the business or the worker can file it. Determinations can take a long time, so it is not a quick fix.
Are part-time or temporary workers automatically contractors?
No. Part-time, seasonal, and temporary workers can all be employees. Hours and duration do not decide classification; control and the nature of the relationship do.
This article is general information for 2026, not tax or legal advice for your situation. Tax rules and figures change; confirm current amounts with the IRS, New York State, or your accountant before acting.
Related service: Bookkeeping & Payroll