W-2 vs. 1099: Employee or Independent Contractor?

How the tax differs

An employer withholds income tax and Social Security and Medicare taxes from an employee's pay, and pays the employer's share of those payroll taxes. A contractor receives gross pay, pays self-employment tax, and usually makes quarterly estimated payments.

Contractors report income and business expenses on Schedule C. Employees generally cannot deduct unreimbursed job expenses on a federal return.

How classification is decided

The IRS looks at the whole relationship, grouped into behavioral control, financial control, and the type of relationship. A worker told when, where, and how to work looks like an employee. A worker with their own tools, multiple clients, and a chance of profit or loss looks like a contractor.

Why it matters

Treating an employee as a contractor can leave a business liable for unpaid payroll taxes and penalties. A worker who thinks they were misclassified can ask the IRS to decide using Form SS-8.

The three categories of evidence

Behavioral control asks whether the business directs how the work is done. Detailed instructions, required training, and set procedures all point toward employment. Financial control asks who bears the business risk. A contractor usually invests in their own equipment, can serve other clients, and can make a profit or a loss on a job. The relationship category looks at written contracts, benefits, how long the work is expected to last, and whether the work is central to the business.

No single factor decides the outcome, and a contract that calls someone a contractor is not conclusive. If the facts show an employment relationship, the label does not change it.

What a business should do before paying

Collect Form W-9 from each contractor before the first payment. It gives the business the contractor's name and taxpayer identification number. If a contractor fails to provide a correct number, the business may need to apply backup withholding, currently 24%.

Form 1099-NEC is generally due to both the contractor and the IRS by January 31. Legislation in 2025 raised the reporting threshold for payments made after 2025, so confirm the current amount each year. Income remains taxable even if no form is issued.

A comparison in numbers

Suppose two people each earn $80,000. The employee pays 7.65% in Social Security and Medicare tax, or $6,120, and the employer pays the same amount again. The contractor pays roughly 15.3% on 92.35% of net earnings, which is about $11,300 on $80,000 of profit, and has no employer contribution. That is why a contractor's rate should be higher than an employee's salary for the same work.

The contractor can deduct business expenses, however, and those deductions reduce both income tax and self-employment tax.

Relief for misclassification

Section 530 relief can protect a business from federal employment tax liability when it had a reasonable basis for its treatment, treated similar workers consistently, and filed the required information returns. The IRS Voluntary Classification Settlement Program lets eligible businesses move workers to employee status for future periods at a reduced cost.

Federal tax rules are not the only test. Labor laws and many states apply their own standards, and some use a stricter test that can treat a worker as an employee even when the IRS would not.

A preparer's checklist

Review each worker's contract, duties, supervision, and how they are paid, and record the reasons for the classification. Treat similar workers consistently, because inconsistency can cost a business Section 530 relief.

Collect Form W-9 before payment, and confirm names and numbers before year-end. Track payments by contractor, and remember that payments made by credit card or through a payment network are generally reported by the processor instead.

Issue Form 1099-NEC by the due date. For employees, check that Form W-2 ties to payroll records and Forms 941, and review any reimbursements paid outside an accountable plan.

Frequently asked questions