New Jersey’s New Misclassification Rules Are Here — and Subcontractors Are Squarely in the Crosshairs

Effective October 1, 2026, New Jersey’s Department of Labor has, for the first time, put the state’s “ABC test” for worker classification into black-letter regulation. For construction subcontractors, the quiet part is now written down — and it is not good news for the way much of the industry actually operates.

What Changed

For decades, New Jersey decided whether a worker was an “employee” or an “independent contractor” using the judge-made “ABC” test. On October 1, 2026, that test became a formal regulation, N.J.A.C. 12:11. The new chapter does not invent a new standard so much as codify — and sharpen — the one the courts already used, and it applies uniformly across the state’s wage, unemployment, temporary-disability, earned-sick-leave and wage-and-hour laws.

Three features of the codified test deserve every subcontractor’s attention:

1. The hiring party carries the burden, and the test is all or nothing. The business that treats a worker as an independent contractor must prove all three prongs — A, B and C. Fail any of them, and the worker is an employee as a matter of law. There is no averaging and no “close enough.”
2. Substance over form is now explicit. Issuing a Form 1099 instead of a W-2 cannot convert an employee into a contractor, and a contract that labels someone an “independent contractor” is not dispositive — its weight shrinks further when the hiring party wrote it, made it non-negotiable or can change or end it at will.
3. The old “paperwork” defense is expressly deflated. This is the big one, and we come back to it below.

The Three Prongs, in Plain English

• Prong A — Control. The business must show it neither controls the work in fact nor reserves the right to control it. Acts taken solely to comply with law, safety rules, or a prime contract don’t, by themselves, count as control.
• Prong B — Outside the usual course (or off-site). The work must be either outside the hiring party’s usual course of business or performed away from all its places of business. “Usual course of business” is now defined broadly — the activities a firm regularly engages in to generate revenue or provide its services — and a business can have more than one.
• Prong C — A genuinely independent business. The worker must be running a real, independent enterprise — one that is “stable and lasting” and able to “survive the termination of the relationship.” Regulators weigh things like the number of the worker’s own employees, investment in tools and vehicles, number of customers, whether the worker sets its own rates and whether it advertises and keeps a visible business location.

Why This Hits Subcontractors Hardest

Here is the structural problem the new rules make plain.  A general contractor subcontracting out distinct trades — painting to a painter, wiring to an electrician — has a real argument that each trade is outside its own usual course of general contracting (Prong B). A specialty subcontractor that subcontracts its own trade does not have that argument. Ever!  When a drywalling company hands drywalling to another drywalling company, the work is squarely within its usual course of business — and because the test is conjunctive, even the strongest of showings on the other prongs cannot rescue a Prong B failure.

That is the single-trade-subcontracting-its-own-trade pattern, and it is common across construction.

The Paperwork Trap: East Bay Drywall

The most important thing the new regulations do is codify the New Jersey Supreme Court’s warning in East Bay Drywall. There, an upstream contractor produced for its drywall subs exactly the documents the industry treats as proof of independence — certificates of insurance and business-registration records. The Court held that proof insufficient, because there was no evidence the entities had their own employees, independent business locations, advertising or customers apart from the contractor. “At worst,” the Court said, the entities were “a business in name only.”

The regulation now says the same thing in so many words: business registration (an LLC or corporation), licensure, carrying insurance and even having multiple customers are each “not alone sufficient” to satisfy Prong C, and where the hiring party required or encouraged the worker to form an entity or carry insurance, that cuts against independent-contractor status. The Court also flagged that “company in name only” arrangements are “particularly damaging in the construction context,” where workers are especially vulnerable.

Translation for subcontractors: the EIN, the certificate of formation and the insurance certificate are the floor, not a shield. A “sub” that is really one person with a 1099 crew and a residential address — holding only entity and insurance paper — is the textbook East Bay profile.

The Direction Nobody Thinks About But Now Must: Your Sub-Subcontractor

Most subcontractors read a piece like this worrying about the general contractor above them. The sharper, newer risk runs the other way — down the chain, to the sub-subcontractor you hire and whose books you never see.

Picture the common scenario: a drywall subcontractor takes a job, then subcontracts part or all of the labor to a smaller drywalling outfit. That lower-tier “sub-sub” shows up with an LLC, a W-9 and an insurance certificate. How it actually pays the people swinging the hammer — W-2, 1099 or cash — you do not know. Assume those workers are, in fact, misclassified. Can you, the trade sub, be responsible for your sub-sub’s misclassification? The answer is: yes, by two different routes, and lack of knowledge protects you against only one of them.

Route 1 — The layer collapses, and the workers become your employees (no knowledge required). The ABC test you face from above, you now apply looking down. If your sub-sub is not a genuinely independent business — the same “business in name only” problem East Bay describes — New Jersey can disregard that layer and treat its crew as your employees under the ABC test. This is direct liability, and it does not turn on what you knew. Because the burden is on the putative employer to prove independence, your not knowing how the sub-sub pays its crew is not a defense — it is a failure of proof that leaves the presumption of employment standing. And New Jersey’s administrative misclassification penalty attaches whenever a wage/benefit/tax violation occurred “in connection with failing to properly classify employees,” with no knowledge or intent element; good faith affects only the size of the penalty, not whether it is owed. A sub-sub that is really one person with a 1099 crew is precisely where this collapse happens — and registration and insurance paper will not stop it.

Route 2 — The construction-industry statute reaches you if you knew (and willful blindness is a live risk). If the sub-sub is a bona fide, independent business that simply misclassifies its own crew, the collapse route weakens and your exposure runs through New Jersey’s construction-industry statute. That law lets a misclassified construction worker sue not only its own employer but any other employer “in contract with” the worker who had knowledge of the misclassification — with attorneys’ fees and class relief available. Here, genuine ignorance may actually help you, but only if courts read “knowledge” as pure actual knowledge. No New Jersey court has yet decided that, so a willful-blindness reading is a real possibility: the more a sub deliberately avoids learning how its sub-sub pays its crew, the more a court may treat that studied ignorance as knowledge. That same statute also prohibits requiring or requesting a worker to sign a document that results in misclassification — so a paper trail designed to engineer ignorance can create its own problem. (How “knowledge” will be construed, and whether it extends to willful blindness, is our read of where enforcement is heading, not a settled holding.)

So, claiming not to know how a sub-sub treats its workers is the wrong posture. Not knowing is not a shield against the collapse route and is risky on the knowledge route. The protective move is the opposite of ignorance: vet the sub-sub the way you would want to be vetted, and document it.

The Risk to Your Own Crew, Concretely

Stepping back up a level, if your own crew can’t satisfy the ABC test, the exposure is real and layered:

• You are the primary target. You are the putative employer of your crew and owe the back contributions, wages and benefits — plus penalties — across the NJDOL-enforced statutes.
• “No knowledge” is not a defense. The administrative penalty has no knowledge or intent element; good faith bears only on the amount.
• Liability climbs the chain — in both directions. The same construction-industry statute that can reach you for a sub-sub’s misclassification can reach your general contractor for yours. Everyone in the chain is now screening everyone else.

What Legitimate Subcontractors Should Do Now

The subs that keep winning work are the ones that can prove they are real businesses — and can show the same about the lower tiers they hire. Practical steps:

• Run real payroll. Treat your field workers as W-2 employees and keep the records — quarterly wage reports, workers’ comp premium audits, payroll-provider documentation — that demonstrate it.
• Build and document independence. Multiple customers, your own tools, vehicles and equipment, your own advertising and business location, and your own pricing are the Prong C factors regulators actually weigh.
• Don’t rely on your LLC and your COI. They are necessary, not sufficient. Expect your general contractors and upstream subs to ask for workforce and payroll proof — and be ready to provide it.
• Vet your sub-subcontractors — don’t stay in the dark. Before you hand labor down a tier, confirm the sub-sub runs real payroll for its own W-2 crew, ask for the same workforce and payroll proof your customers ask of you, flow your wage-and-hour and classification expectations down in writing and reserve the right to verify. Staying ignorant does not protect you; it is the exposure.
• Mind the documents you ask anyone to sign. A certification regime designed to paper over how a crew is actually paid can itself violate the construction-industry statute.
• Do not rely solely on a tax analysis. Your tax advisors may look at this issue only from the viewpoint of what the various tax laws and regulations consider.  While similar, the tax and federal labor tests have marked differences, most notably Prong B/usual course of business.  Do not rely solely on tax advice; consult with experienced counsel for guidance.

The Bottom Line

New Jersey did not rewrite the misclassification test on October 1 — it wrote the existing one down, defined the terms the courts had left fuzzy and slammed the door on the defense of having collected an insurance certificate and an LLC filing. For specialty subcontractors, and especially those who subcontract their own trade — or sub it down yet another tier — the message is blunt: the structure that felt like ordinary industry practice is now the structure regulators are told to scrutinize, and not knowing what happens below you is a liability, not a defense. The subcontractors who treat their workers as employees, document their own independence and vet the lower tiers they hire will be the ones still standing when the audit letter arrives.

If you have any questions on these misclassification rules, reach out to your Cohen Seglias contact or our Construction Group.