Who’s the Boss? Independent Contractor vs. Employee Misclassification Risks

Classifying a worker as an independent contractor instead of an employee can seem like a simple decision—until it leads to a tax audit, wage claim, or state investigation. Whether it’s a delivery driver, a freelance graphic designer, or a part-time bookkeeper, getting this classification wrong can have serious financial consequences.

And while the federal IRS test and the U.S. Department of Labor’s standards matter, New York and New York City have their own rules that make things even trickier—including New York City’s Freelance Isn’t Free Act (FIFA), which imposes strict contract and payment requirements.

This article breaks down how to tell the difference, how to protect your business, and why erring on the side of “employee” might save you a lawsuit. First, we’ll explain the different legal tests used by various agencies. Then, we’ll walk through what the economic realities test actually looks like in the real world. You’ll also see common examples where businesses get tripped up. From there, we’ll cover how New York City’s Freelance Isn’t Free Act adds another layer of obligation—and risk. Finally, we’ll share what steps every employer should take to stay compliant.

There’s no single rule that applies in every case—but there are multiple legal tests used by different agencies. The most commonly referenced include the IRS 20-Factor Test, which focuses on behavioral and financial control; the U.S. Department of Labor’s Economic Realities Test, which considers economic dependence; and the New York State and City tests, which evaluate the degree of control, independence, and the nature of the business relationship.

The heart of the economic realities test is simple: Is the worker truly running their own business, or are they economically dependent on yours?

A true independent contractor works for multiple clients, sets their own schedule, and decides how to complete the work. An employee is typically tied to one employer, follows internal rules, and has little control over how the work gets done.

Here’s a simple way to understand the difference:

Imagine you hire a plumber. You explain there’s a leak. The plumber chooses when to arrive, uses their own tools, and invoices you after the job. That’s a contractor.

Now picture a “marketing consultant” who works in your office from 9 to 5, uses your laptop, must get approval before sending out anything, and isn’t allowed to work for other companies. Despite the title, they’re likely an employee.

Many employers assume that if both sides agree to an independent contractor arrangement, it’s legally valid. But mutual consent isn’t enough. Misclassification isn’t about what the contract says—it’s about what actually happens.

Consider a delivery driver working under a contractor agreement. Everything runs smoothly—until they slip and fall during a delivery and file a workers’ comp claim. Or they’re let go and apply for unemployment benefits. Suddenly, you’re facing audits, back premiums, penalties, and possibly a wage claim.

Let’s say a bakery hires a “freelance cake decorator” who works 30 hours per week, on a fixed schedule, using company equipment and taking direction from the head baker. Their contract says independent contractor, but their duties say employee.

When courts and agencies step in, they’ll look at the facts—not the title. Misclassification can lead to serious consequences:

Estimated Financial Exposure:

Since 2017, New York City’s Freelance Isn’t Free Act has protected freelance workers by requiring contracts, timely payment, and protections against retaliation.

If you hire a freelancer in NYC for $800 or more (including across multiple projects within 120 days), you must put the terms in writing. Payment must be made within 30 days unless otherwise stated. Retaliation for asserting rights is strictly prohibited.

Violations can lead to statutory damages, double damages, attorneys’ fees, and public enforcement.

Misclassification mistakes are often unintentional—but that doesn’t lessen the legal risk. A few practical changes can help:

At Jacobs & Associates, we help employers navigate the line between compliance and flexibility. Whether you’re drafting contracts, responding to a complaint, or building out a new team, we’re here to help you do it right.

Keep Fighting the Good fight.