What is the difference between a contractor and an employee?
A worker is an employee, not a contractor, when the business controls or has the right to control what is done and how. The IRS weighs behavioral control, financial control and the type of relationship. The Department of Labor uses a separate economic reality analysis. The label in the contract does not decide it.
US federal rules as of 31 October 2026. State tests can be stricter.
At a glance
- Two federal tests matter: the IRS common-law test (taxes) and the Department of Labor test under the Fair Labor Standards Act (wages and overtime).
- No single factor decides. Weigh all of them and document your reasoning.
- If a worker is an employee, you owe payroll tax withholding, minimum wage and overtime where covered, and use Form W-2. For a contractor you collect Form W-9 and generally report payments on Form 1099-NEC.
- States apply their own tests, which can be stricter than federal rules.
How does the IRS decide?
The IRS groups the evidence into three categories:
| Category | Question | Points toward employee | Points toward contractor |
|---|---|---|---|
| Behavioral control | Do you control, or have the right to control, what the worker does and how? | Set hours, required methods, training on your processes | Worker decides how and when to deliver a result |
| Financial control | Do you control the business side of the job? | You provide tools, reimburse expenses, set pay method | Worker uses own tools, invoices, can profit or lose |
| Type of relationship | How do you both see the relationship? | Employee-type benefits, indefinite term, work is core to your business | Written contract for a defined project, no benefits |
If you cannot tell, either the business or the worker can file Form SS-8 and the IRS will determine the status. The IRS says that can take a long time, so do not wait on it to start work.
How does the Department of Labor decide?
On 10 January 2024 the Wage and Hour Division published a final rule revising its guidance on employee or independent contractor status under the FLSA, effective 11 March 2024. It replaced the 2021 rule and is codified at 29 CFR Part 795. It uses an economic reality analysis: is the worker economically dependent on you, or really in business for themselves. Check the Department of Labor page for updates, because this guidance has changed before and the page notes it will be updated.
What does misclassification risk?
- Back payroll taxes and penalties from the IRS.
- Unpaid minimum wage and overtime for covered workers under the FLSA.
- State claims for unemployment insurance, workers' compensation and benefits.
- A worker who thought they were a contractor can ask a government agency to review their status.
A practical checklist before you hire a 1099 worker
- Can the worker choose how, when and where to do the work?
- Do they use their own equipment and bear their own costs?
- Do they serve other clients or market to the public?
- Is the engagement for a defined project or deliverable?
- Do you offer them none of your employee benefits or training?
- Is a signed written agreement in place, with a clear scope and payment on invoice?
- Did you collect a Form W-9 and keep it on file? The IRS says to keep it four years.
- Have you checked the state test where the work is done?
If several answers are no, treat the worker as an employee and use the employee hiring steps.
Employer of record is not a shortcut
An employer of record can legally employ a person on your behalf. That is different from calling a worker a contractor to avoid employment obligations.
FAQ
Can a contract say the worker is a contractor and settle it? No. The IRS says the relationship is judged on the facts, whatever it is called.
Do contractors file Form W-2? No. Wages to employees go on Form W-2. Payments to contractors are generally reported on Form 1099-NEC.
Where does the threshold for reporting come from? The reporting threshold and exceptions are in the IRS instructions for Forms 1099-MISC and 1099-NEC. Check the current year.
Sources
- IRS, Independent Contractor (Self-Employed) or Employee - https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee (accessed 31 October 2026)
- IRS, Independent Contractor Defined - https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-defined (accessed 31 October 2026)
- IRS, Forms and Associated Taxes for Independent Contractors - https://www.irs.gov/businesses/small-businesses-self-employed/forms-and-associated-taxes-for-independent-contractors (accessed 31 October 2026)
- US Department of Labor, Wage and Hour Division, FLSA - https://www.dol.gov/agencies/whd/flsa (accessed 31 October 2026)
- US Department of Labor, Misclassification - https://www.dol.gov/agencies/whd/flsa/misclassification (accessed 31 October 2026)
This is general information, not legal, tax or immigration advice. Rules change and your situation may differ. Consult a licensed attorney or qualified adviser.