Correctly classifying a worker as an employee or an independent contractor determines tax obligations, workplace rights, and your long-term legal exposure. Pennsylvania uses specific tests to evaluate classifications, and getting them wrong can trigger audits and penalties that affect your business operations.
How Pennsylvania Determines Whether Someone Is an Employee or Contractor
Pennsylvania does not rely on a single rule. Worker classification depends on the agency’s review of the relationship. When you hire someone, we want you to understand how each test works so you can judge your exposure before an issue develops.
Pennsylvania Unemployment Compensation (UC) Test
The PA Department of Labor & Industry applies a two-part test. A worker is an independent contractor only if both conditions are met:
- Freedom from control or direction during the performance of services
- Customarily engaged in an independently established business, which includes having separate business filings, their own tools, the ability to perform work for others, and holding financial risk
If either part fails, the worker is considered an employee for UC purposes.
Pennsylvania Workers’ Compensation Act
The Workers’ Compensation Bureau focuses on the right to control the work. Courts review factors such as:
- Who sets work hours
- Whether tools and equipment are provided
- How the worker is paid
- Whether the worker can refuse assignments
- Whether the relationship is project-based or indefinite
Because no single factor controls the outcome, we help employers evaluate risk based on the full relationship.
IRS Common Law Test
The IRS uses a three-category framework:
- Behavioral control, which asks whether you direct how tasks are performed
- Financial control, which examines reimbursement, investment, and payment structure
- Type of relationship, which looks at contracts, benefits, and permanence
If the IRS finds that you control most aspects of the work, the individual is likely an employee, even if they were labeled as a contractor.
Common Misclassification Triggers and Red Flags
Audits rarely happen by chance. Most begin after an event that signals possible problems.
Common triggers include:
- A worker files for unemployment and lists you as an employer
- A contractor files a workers’ compensation claim
- A tax return or 1099 does not match IRS records
- A competing business reports irregularities
- Multiple contractors perform the same role as regular employees
When any of these signs surface, agencies often expand the review into payroll practices and benefit eligibility.
Consequences of Misclassification in Pennsylvania
Misclassification carries significant financial fallout. Even if the mistake was unintentional, the penalties can extend back several years.
Consequences may include:
- Liability for unpaid payroll taxes
- Interest and penalties from the IRS
- Workers’ compensation premium adjustments
- Unemployment compensation contributions
- Owed overtime and wage claims under Pennsylvania and federal labor laws
- Potential civil litigation or class actions
We work with employers who discovered misclassification only after an audit began, and the retroactive costs can be substantial.
How to Document Contractor Relationships to Withstand Scrutiny
Clear documentation reduces audit risk and shows that your contractor relationships are legitimate. Written contracts matter, but agencies look for proof that the relationship reflects actual independence.
Stronger contractor documentation includes:
- A written agreement that outlines project scope, payment terms, deliverables, and lack of control
- Clear statements that the contractor sets their own hours and determines how work is performed
- Proof that the contractor uses their own tools or equipment
- Invoices and payment logs instead of employee-style payroll
- Evidence that the contractor offers services to other clients
- Records showing the contractor bears some financial risk
We encourage employers to conduct regular classification audits and keep documentation updated. When the actual working relationship changes, your classification analysis should change as well.
Get Classification Right Before Problems Start
Worker classification affects your tax obligations and your exposure to wage claims. When you understand Pennsylvania’s tests and the IRS rules, you put your company in a stronger position. If you need support evaluating your current workforce or responding to an audit, Jones, Gregg, Creehan & Gerace will help you correct issues and protect your operations.
Contact us today so we can help you review your classification practices with confidence.