Navigating Worker Classification Rules Across the U.S.

Properly classifying workers as either W-2 employees or 1099 independent contractors is a critical compliance responsibility for any business. Worker classification affects everything from tax obligations and benefits to legal liability and business risk. Misclassification can result in serious penalties, so it’s important for businesses to understand the legal standards and how they vary by state. 

This guide outlines key concepts related to worker classification, explains the “ABC test” used in many states, and provides examples to help clarify the distinction. This information is intended for general guidance and should not replace professional legal advice. 

Why classification matters

When a worker is classified as a W-2 employee, the employer has specific obligations, including withholding federal and state taxes, paying employer taxes (e.g., Social Security, Medicare, and unemployment), providing required benefits (e.g., health insurance and paid sick leave), and issuing a W-2 tax form. 

When a worker is classified as a 1099 independent contractor, the worker is considered self-employed and is responsible for managing their own taxes and benefits. The hiring company typically has limited control over how the work is performed and is not responsible for providing benefits or withholding taxes. 

Strict classification states

Proper classification matters in all states. However, some states have especially strict standards for determining whether a worker can be treated as an independent contractor. In these jurisdictions, it is often difficult to meet the legal threshold for 1099 classification, and workers are more likely to be treated as W-2 employees. Examples of states with more restrictive classification rules are included below, but please note, this is a point-in-time list, and the classification risks are ever-changing for these (and all) states: 

• California

• Colorado

• Delaware

• Massachusetts

• Nebraska

• New Jersey

• New York

• Ohio

• Oregon

• Pennsylvania

• Vermont

• Washington

 

Businesses operating in these states should be especially cautious and consider conducting classification audits or consulting legal counsel. 

Determining proper classification using the ABC test

Many states use the ABC test to determine whether a worker qualifies as an independent contractor. To be classified as a contractor under this test, all three conditions must be met: 

1. The worker is free from the control and direction of the hiring entity in connection with the performance of the work.

Example: A freelance web designer is hired to build a website and independently determines how to complete the project. 

2. The work performed is outside the usual course of the hiring entity’s business.

Example: A software company hires a freelance videographer to produce a brand video. 

3. The worker is customarily engaged in an independently established trade or business.

Example: A consultant who operates their own LLC, advertises services online, works with multiple clients, and provides their own tools. 

Some states may use variations of the ABC test, the IRS common law test, or their own classification criteria. Businesses must be aware of the applicable rules in every state where they operate. 

Risks of misclassification

Misclassifying an employee as a contractor can have serious financial and non-financial consequences. These include: 

• Owed back taxes, including Social Security, Medicare, and unemployment insurance for the entire period of misclassification

• Owned back employee pay, including overtime, for the entire period of misclassification

• Fines of up to $25,000 per misclassified worker

• Liability for employee benefits under the IRS Employer Shared Responsibility Provision

• Loss of reputation and trust among workers and clients

• Potential audits or investigations from state and federal agencies

 

Because of these risks, businesses should establish strong internal processes—or work with a compliance partner—to assess worker classification before formalizing the employment relationship with their current or future team. 

Recent misclassification examples

FedEx Ground and Home Drivers (2020): The largest misclassification lawsuit in the USA was a case involving FedEx and its ground and home delivery drivers, settling for a total of $466 million. This included a $228 million settlement in California in 2015 and a $240 million settlement in 20 states in 2016. The lawsuits stemmed from FedEx’s allegedly misclassifying drivers as independent contractors rather than employees.  

Uber and Lyft’s $175 Million Settlement in Massachusetts (2024): In June 2024, Uber and Lyft reached a $175 million settlement with Massachusetts prosecutors after a four-year legal battle over driver compensation and classification. The agreement mandates a minimum wage of $32.50 per hour, paid sick leave, healthcare stipends, and occupational accident insurance for drivers. Uber agreed to pay $148 million, and Lyft $27 million, to be distributed as restitution to current and former drivers. This settlement provides significant benefits but does not change the classification of drivers as independent contractors. 

Horseless Carriage Carrier, Inc. Settlement (2024): In July 2024, Horseless Carriage Carrier, Inc., a luxury car transporter based in Paterson, N.J., agreed to pay $455,000 to settle claims of misclassifying eight drivers as independent contractors. The settlement included $364,000 in unpaid wages to the affected drivers, with the remainder covering fees and penalties. The New Jersey Department of Labor and Workforce Development emphasized that misclassification deprives workers of essential benefits and protections. 

Uber and Lyft Wage Theft Allegations (2025): In March 2025, the state of California initiated settlement negotiations with Uber and Lyft over allegations that the companies misclassified drivers as independent contractors, resulting in substantial wage theft. The state contends that this misclassification denied drivers rightful wages and benefits. These negotiations aim to address the claims and potentially lead to significant financial settlements for the affected drivers. 

How AllWork Can Help

Managing a blended workforce of employees and independent contractors across the U.S. and Canada can be complex, but AllWork makes it simple. As an Employer of Record (EOR) and workforce management platform, AllWork helps businesses stay compliant, reduce administrative burden, and scale faster with flexible talent.

Here are a few ways we can help: 

• Worker classification support: We can help determine whether a worker should be classified as a W-2 employee or a 1099 independent contractor, using a combination of job details, location, and legal guidance to reduce risk.

• EOR services: For workers classified as employees, AllWork serves as the legal employer, handling payroll, tax withholdings, benefits, and compliance.

• Contractor payment management: For contractors, AllWork streamlines onboarding, documentation, and payments while ensuring compliance with contractor laws in all jurisdictions.

• Cross-border capabilities: We operate under our own EIN in the U.S. and BN in Canada, making it easy for companies to engage talent across both countries without setting up a legal entity.

• Compliance first: Our expert team stays up to date on evolving labor laws so you don’t have to—from the ABC test to paid sick leave mandates.

The result? You get a single, unified platform to onboard, classify, and pay your workforce, compliantly and confidently. 

Want to check out the AllWork platform? You can schedule a demo here.

Disclaimer: This article is intended for informational purposes only and does not constitute legal advice. Businesses should consult legal counsel for specific classification questions based on their circumstances and applicable laws.