Classifying a worker an “employee” versus an “independent contractor” is not as simple as checking whether they receive a W-2 or a 1099. The U.S. Department of Labor (DOL) uses the economic reality test to determine whether a worker is an employee or an independent contractor. The test consists of six factors that are weighed together. When examined comprehensively, the factors are aimed at asking a fundamental question: Does the worker depend on the employer for work, or is the worker running their own business? In other words, who is in control of the work?

Economic Reality Test

  • Opportunity For Profit or Loss Depending on Managerial Skill: If the worker can influence their earnings—by negotiating pay, choosing when to work, hiring others, or purchasing materials—then this factor may weigh in favor of independent contractor status.
  • Investments by the Worker and the Employer: If the worker invests in growing their business—such as marketing, client/customer acquisition, and reducing overhead—then this factor tends to support independent contract status. These types of efforts tend to indicate that the worker may be functioning independently of the employer.

    The North Carolina Department of Labor includes a seventh factor here: Degree of Independent Business Organization and Operation. This factor requires a deeper examination into the worker’s ability to function in the absence of the employer. Greater independence and less reliance on the employer tend to point toward independent contractor status.

  • Permanence of the Work Relationship: Temporary or project-based, fixed duration work tend to suggest independent contractor status. Whereas ongoing, indefinite relationships and continuity of work tend to suggest employee status.
  • Nature and Degree of Control: The more control or regulation the employer has over a worker’s compensation, hours, work product, performance, or exclusivity, the more likely the worker is an employee.
  • Whether the Work Performed is Integral to the Employer’s Business: If the work performed is central to the business’s operations, it likely indicates employee status.
  • Skill and initiative: The more initiative and independent judgment on the part of the worker, the more likely the worker is an independent contractor. In situations where the employer has significant authority over the worker and method of performance—for example, by training the worker or directing the worker with specific tasks—then this factor tends to support employee status. In situations where the worker has more range to accomplish broader goals—for example, improving strategy—then this factor tends to support independent contractor status.

No single factor is determinative, and the economic reality test is not intended to serve as a checklist. Instead, the factors are considered together and evaluated in light of the specific facts and circumstances surrounding the worker’s relationship with the business.

There may be exceptions and carve-outs for specific professions. For example, under federal law, the Internal Revenue Service (IRS) provides guidance for licensed real estate agents. Other exceptions or variations may exist under state law or in specific industries. It is important for businesses to understand both federal and state classification rules when evaluating worker status. Our Employment Law practice group has experience navigating complex compliance frameworks, and we stand ready to assist your business.