Tell an employee from an independent contractor before you pay

What is an independent contractor vs employee

An employee is a person who works for you when you have the right to control the work. An independent contractor is a person in business for themselves. People also call that person a 1099 worker, after the form you may file. The nickname is not the legal test.

Withholding means money you take out of a payment and send to a tax agency. For an employee, you generally withhold income tax, Social Security tax, and Medicare tax. You also pay the employer share of Social Security and Medicare, and you may owe unemployment tax. For an independent contractor, you generally do not withhold or pay those taxes. The IRS states that split on its independent contractor or employee page.

The IRS is the Internal Revenue Service, the federal tax agency. The same page says the person can also be a statutory employee or a statutory nonemployee. A statutory employee is someone the tax law treats as an employee in a special case. A statutory nonemployee is someone the tax law treats as self-employed in a special case. Most first payments use the common-law test below. A common-law test looks at control and independence, not at the job title. Read that page before you use a special case.

A written contract that says “contractor” does not settle the label. The IRS says to look at the whole relationship, and to write down the facts you used.

IRS contractor vs employee

For federal employment tax, the usual test is that common-law test. IRS Topic 762 says the facts fall into three groups.

Behavioral control

Behavioral control asks whether you have the right to direct what work is done and how it is done. Instructions and training point toward an employee. You do not have to use that right. The right is enough.

Financial control

Financial control asks whether you direct the business side of the job. Topic 762 lists unreimbursed expenses, investment in tools, whether the person offers the work to other customers, how you pay, and whether the person can make a profit or take a loss.

Type of relationship

The type of relationship includes a written contract, employee benefits such as insurance or paid vacation, how long the work lasts, and whether the work is a key part of your regular business.

There is no set number of facts that makes the person an employee. No one fact stands alone. Weigh them together. Publication 15-A, the IRS Employer’s Supplemental Tax Guide, is the longer guide Topic 762 points to.

Working from home does not decide it. The IRS says a remote worker is your employee under the common-law rules if you can control what will be done and how it will be done. That stays true when the person chooses to work away from your office.

The Labor Department uses another test

The U.S. Department of Labor is the federal labor agency. People also call it the DOL. For minimum wage and overtime, it uses the Fair Labor Standards Act. That is the federal wage-and-hour law. That law asks a different question from the IRS.

The economic reality test asks whether the person depends on you for work, or is in business for themselves. 29 CFR § 795.105 says an employee is economically dependent on the employer for work. An independent contractor is in business for themselves. That dependence is not about the size of the paycheck, or whether the person has other income. Calling the person an independent contractor does not turn off minimum wage or overtime.

29 CFR § 795.110 says to look at the whole relationship. No one factor decides it. The factors include a chance of profit or loss from running the work, investment in the business, how lasting the job is, how much control you keep, whether the work is central to your business, and skill used with business initiative. Other facts can count. The Labor Department misclassification page points to that rule, in 29 CFR Part 795. Misclassification means you treated an employee as an independent contractor.

The IRS answer and the Labor Department answer can differ. Do not treat one agency’s label as the other agency’s label.

Form W-2 or Form 1099-NEC

Form W-2 is the Wage and Tax Statement. You file it for an employee. The About Form W-2 page says an employer who pays an employee for services must file Form W-2 for each employee. That includes a case where income tax, Social Security tax, or Medicare tax was withheld. The page lists the other cases and points to the Form W-2 instructions for the reporting threshold.

Form 1099-NEC is Nonemployee Compensation. You use it to report pay to someone who is not your employee. The instructions for Form 1099-NEC say to file it for each person in your business to whom you paid at least $2,000 for services by someone who is not your employee, or for certain attorney payments. Those instructions, revised December 2026, say that for tax years beginning after 2025 that reporting amount is $2,000. It may be adjusted for inflation beginning in 2027.

You also file Form 1099-NEC if you withheld any federal income tax under the backup withholding rules, no matter the dollar amount. Backup withholding is a special withholding rule those instructions name. The same instructions list payments you do not report, including many payments to a corporation. Read them before you file. The form itself is on the About Form 1099-NEC page.

The form follows the label. It does not create the label. Filing Form 1099-NEC does not make the person an independent contractor if the tests above say the person is an employee.

What happens if you get the label wrong

If you treat an employee as an independent contractor and you have no reasonable basis for that choice, the IRS says you may be held liable for employment taxes for that worker. The IRS points to Internal Revenue Code section 3509 for that bill. The rates are in the statute.

A relief rule can apply when you had a reasonable basis for not treating the worker as an employee. The IRS says you must file the required federal information returns in line with that treatment. You, or a business you took over, must not have treated a worker in a substantially similar job as an employee for any period beginning after 1977. Publication 1976 is the IRS sheet on that relief. Relief does not decide that the person is an independent contractor. The person can still be found to be an employee another way. One way is Form SS-8, the IRS form that asks for an official status decision. That form is explained below.

A worker who thinks the label was wrong can file Form 8919, Uncollected Social Security and Medicare Tax on Wages, with their income tax return. The IRS also offers the Voluntary Classification Settlement Program. That program lets an eligible business treat the workers as employees going forward, with partial relief from federal employment taxes. You apply on Form 8952. Read the IRS page for who qualifies.

Ask the IRS with Form SS-8

Form SS-8 is Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The firm or the worker can file it. The filing asks the IRS whether the work is that of an employee or an independent contractor for those federal taxes.

The IRS independent contractor page says the IRS reviews the facts and officially determines the worker’s status. It also says a determination may take at least six months. Use Form SS-8 when the common-law facts are still unclear, or when you keep hiring the same kind of worker. The form is on the About Form SS-8 page. A Form SS-8 filing is not a substitute for the state page.

State rules stay on the state page

The IRS test is for federal employment tax. The Labor Department test is for minimum wage and overtime. A state can use its own test for unemployment tax, wage rules, or workplace injury insurance. Do not copy one state’s rule onto another state. The state employer page is the paperwork after you decide the person is an employee. It is not the federal label test.

If the person is an employee, Texas, Florida, and Washington still have employer paperwork. None of those states takes state income tax from a paycheck. A missing state income tax does not make the person an independent contractor. Each page covers that state’s unemployment tax and the other first-hire jobs.

California covers the Employment Development Department account and workplace injury insurance before work starts, once the person is an employee. New York covers the registration for an employee, and it notes a separate new-hire report that can include some contractors. Illinois, New Jersey, Massachusetts, and Ohio also put some people you call contractors on a new-hire report. That report is not the IRS test. Do not use one of those reports as another state’s rule.

Pennsylvania covers unemployment and withholding when the person is an employee. Local earned income tax is a separate collector on that page. It does not set the federal label.

If the person is an employee

If the person is an independent contractor, you generally do not withhold income tax, Social Security, or Medicare. You may still have a Form 1099-NEC. Use the IRS instructions for the dollar test.

If the person is an employee, use Hiring your first employee. That list is the federal work before payday. Can I do my own payroll? is the repeating payday after the accounts exist. The methodology page explains the three grades on this site. The directory shows those grades by state.

Gusto is one plain link. Patriot is the other service on this site.