How the line is drawn
Regulators look at the substance of the relationship, not the label on the contract. The recurring themes are behavioral control (who decides how the work gets done), financial control (who supplies tools, who bears profit and loss), and the nature of the relationship (permanence, benefits, whether the work is core to the business).
Different agencies and states apply different tests — including the stricter ABC test used in several jurisdictions — so a worker can be a contractor federally and an employee at the state level.
What misclassification costs
Back taxes and unpaid withholdings, plus interest and penalties.
Unpaid overtime, benefits, and unemployment contributions.
Class-action exposure and, in some states, personal liability for officers.
Reducing the exposure
Document the relationship honestly, review it when the scope of work changes, and re-test long-running contractor engagements at least annually.
Where the classification is genuinely borderline, engaging the worker through an Employer of Record converts the question into a W-2 employment relationship and removes the exposure entirely.