Introduction

Determining whether a worker is an employee or an independent contractor remains one of the most important—and increasingly complicated—decisions an employer must make.  The stakes are high:  classification affects tax obligations, minimum wage and overtime compliance, benefit eligibility, and exposure to legal claims.  As of 2025, both federal and state agencies have tightened scrutiny, and employers with workforces across multiple states must contend with a patchwork of rules and risks.

A New Federal Standard:  Six-Factor "Economic Realities" Test

In 2024, the U.S. Department of Labor (DOL) adopted a six-factor test under the Fair Labor Standards Act (FLSA), replacing the prior 2021 rule.  Effective March 2024, this test considers:

1. Opportunity for profit or loss based on managerial skill;
2. Investments by the worker and employer;
3. Permanency of the work relationship;
4. Control the employer exercises over the work;
5. Whether the work is integral to the business;
6. The worker’s skill and initiative.

Unlike prior rules, no one factor is determinative, and the analysis depends on the totality of the circumstances.

State-Level Complexity:  The ABC Test and Beyond

At the state level, classification standards vary widely.  For example, California, Massachusetts, and New Jersey apply the ABC Test, which presumes a worker is an employee unless the employer can show:

     A. The worker is free from control and direction;
     B. The work is outside the usual course of the employer’s business;
     C. The worker is independently established in that trade.

Other states continue to use the IRS 20-Factor Test, common-law right of control test, or industry-specific rules.  This divergence creates significant compliance risks for employers with operations in multiple states, especially where federal and state standards differ.

Misclassification Risks:  Financial, Legal, and Reputational

Improper classification may expose employers to:

• Back pay and overtime violations under the FLSA or state law;
• Unemployment insurance and workers’ compensation liabilities;
• IRS penalties for failing to withhold and remit payroll taxes;
• Exclusion from benefits (healthcare, retirement) in violation of the ACA or ERISA;
• Ineligibility for anti-discrimination protections, such as Title VII, ADEA, or ADA;
• Class action lawsuits and enforcement actions.

Regulators and plaintiff attorneys are paying close attention to industries with high rates of contractor use—particularly gig economy, logistics, and professional services.

Employer Action Items

To manage risk and ensure compliance:

• Conduct periodic classification audits—especially for contractors working on-site, under set schedules, or using company-provided tools;
• Update contractor agreements to reflect independent business operations and avoid language suggesting control;
• Tailor policies for each state in which you operate—what qualifies as a contractor in Texas may not pass muster in California;
• Stay informed about litigation trends and evolving regulatory guidance;
• Consult legal counsel before hiring or reclassifying large segments of your workforce.

Conclusion

In 2025, getting classification wrong is more costly than ever.  As federal and state laws continue to evolve—and diverge—employers must take proactive, state-specific steps to assess risk and protect their business.  Compliance today may prevent costly litigation tomorrow.

If you have any questions or concerns, please contact Alexander (A.J.) Palutis, Esq. of our Employment Law Group at apalutis@c-wlaw.com or (717) 390-3020.

Disclaimer

The information in this article is provided for general informational purposes only and may not reflect the current law in your jurisdiction.  By reading this article, you understand that there is no attorney-client relationship between you and Cipriani & Werner, P.C. or any of our attorneys.  No information contained in this article should be construed as legal advice from Cipriani & Werner, P.C. or the individual authors.