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In recent years, there has been an increase in the number of businesses classifying workers as independent contractors rather than employees. While there are several differences between these two types of workers, the biggest (and most important to you as an employer) is the requirement to deduct the various payroll taxes from each W-2 employee’s paycheck, while 1099 independent contractors are responsible for filing and handling all their taxes on their own.
The second, related difference is which tax form is used to report a worker’s income to the IRS. Employees are sometimes referred to as “W-2 employees” because they receive IRS Form W-2 from you. Contractors, on the other hand, should receive Form 1099 to report their earnings.
Contractor or employee?
While businesses typically handle worker classification internally, the IRS can sometimes step in to make the final determination as to whether the person you just hired is really an independent contractor, or whether they should be on the payroll. Here’s a quick cheat sheet for telling the difference so you can classify your staffers correctly:
Generally, a worker should be classified as an employee if:
- You control how they perform their work
- You provide the necessary equipment (computer, supplies, phone, office space) needed to complete the work
- You provide benefits such as insurance or paid time off
- You pay or reimburse them for expenses associated with their job, like purchasing business supplies
- You pay them in regular pay periods
On the other hand, a worker is likely to be considered an independent contractor if:
- They provide services to many different clients who pay them for those services
- They retain complete control over how and when the work is performed
- They use their own equipment and facilities to perform most of their required work
- You pay them after they submit invoices
Did you know?
Because independent contractors complete tasks or provide services without being classified as employees, when they get paid, they receive nonemployee compensation.
How do you tell the difference between an employee and an independent contractor?
Let’s look at a couple of examples. Let’s say John is hired to provide social media support to a business, but he is required to use a company computer, report to work at a certain time, and complete work in a specific manner. In this case, John should be classified as an employee. However, if John is hired to provide social media support to a company and he handles this work using his own equipment, on his schedule, and works with other small businesses to offer the same services, John should be classified as an independent contractor.
The correct classification is essential, particularly since businesses are required to withhold and pay federal and state taxes, Social Security and Medicare, and unemployment taxes for each employee, while no taxes are withheld or paid for independent contractors. This is why the IRS looks very carefully at how a worker is classified.
If you’re still uncertain, Form SS-8 can be filled out and submitted to the IRS. This form asks the IRS to make a determination on how your worker should be classified and whether you should file a W-2 or 1099. It can also be used by workers who believe they should be classified differently. We also have a separate resource on what an SS-8 form is used for and how to complete it.
This can be a lot to keep track of, so the table below summarizes the main differences between independent contractors and employees for quick reference.
| Employee | Independent Contractor |
| Required to comply with employer’s instructions about when, where, and how to work | Sets own hours; determines own sequence of work |
| Works exclusively for the employer | Can work for multiple employers; services available to the public |
| Hired by the employer | Is self-employed |
| Subject to dismissal; can quit without liability | A contract governs how the relationship can be ended |
| Has a continuing relationship with the employer | Works by the job |
| Personally completes work | Permitted to employ assistants |
| Performs services under the company’s name | Performs services under the worker’s business name |
| Paid a salary; reimbursed for expenses; participates in company’s fringe benefits programs | Payment by the job; opportunity for profit and loss |
| Furnished tools, equipment, materials, and training | Furnishes own tools, equipment, and training; substantial investment by the worker |
| If an outside salesperson:
The company provides leads, sets terms and conditions of the sale, assigns a territory, and controls the sales process |
Controls the sales process and terms |
Before we go, let’s touch on some things to keep in mind if there’s a mishap when classifying a worker.
Did you know that there’s another way to classify workers? Learn what a statutory employee is and how to know if you’re about to hire one.
What happens if you misclassify a worker?
The IRS doesn’t fool around when it comes to classification (or much else), so there could be a penalty involved if they determine that workers have been misclassified — accidentally or not. This penalty can include holding the business liable for any and all employment taxes for the worker(s) in question.
However, the IRS currently offers a voluntary classification settlement program for business owners who agree to 1) reclassify their workers for future tax periods, and 2) agree to pay 25 percent of the employment tax liability for the most recent tax year.
Ease of use
OnPay has been an incredible time saver and made the process of running payroll so easy. It truly is payroll software built for small business people since we have all types of employees who are salaried, hourly, and independent contractors, and no matter who we work with, it’s simple to use (and their support team is great to work with).
— Pam Snyder, Sherman-Stoltz Law Group
W-2s, 1099s, and other paperwork
The employee vs. contractor question also has an impact on some of the paperwork you’ll need to take care of. When hired, independent contractors must complete Form W-9 which should be kept on file for four years. If a worker is classified instead as an employee, they need to fill out Form W-4 to determine the level of federal tax that should be withheld from their paycheck. W-4s should also be kept on file for four years after the date the employment tax becomes due or is paid (whichever is later). Remember, you’ll also need to collect withholding forms if you collect state and local taxes.
At the end of the year, there’s also a difference in the tax documentation you send to employees and independent contractors. As mentioned previously, contractors should receive a copy of Form 1099-NEC, while employees will receive Form W-2.
If you would like additional information on classifying workers, please visit the IRS website, which provides an entire section on independent contractors and employees. Or talk to a tax or HR advisor to get more information. Getting those W-2s and 1099s right will save you a lot of time and potential liability down the road.
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Jon Davis is the Sr. Content Marketing Manager at OnPay. He has over 15 years of experience writing for small and growing businesses. Jon lives and works in Atlanta.