Employees vs. independent contractors

How does the IRS decide if a worker is an employee?

The IRS uses the common-law rules. Facts that show how much control you have, and how independent the worker is, fall into three categories (IRS: Employee (common-law employee)):

• Behavioral control. Do you control, or have the right to control, what the worker does and how they do it?
• Financial control. Do you control the business side of the job, such as how the worker is paid, whether expenses are reimbursed and who provides the tools?
• Type of relationship. Are there written contracts or employee-type benefits, will the relationship continue, and is the work a key part of your business?

No single fact decides it; the IRS weighs the whole relationship (IRS: Independent contractor or employee?). If you are unsure, you or the worker can file Form SS-8 to ask the IRS to determine the worker's status, though the IRS says a determination can take at least six months (IRS: About Form SS-8).

How does the Department of Labor decide?

For minimum wage and overtime under the Fair Labor Standards Act, the Department of Labor asks a different question: a worker is an employee if the economic realities show that the worker is economically dependent on the employer for work (DOL: Fact Sheet 13). The Department's rule on this test is changing. In February 2026 it proposed rescinding its 2024 rule and focusing on two core factors, control over the work and the worker's opportunity for profit or loss (DOL: 2026 rulemaking). Check the Department's page for the rule in force when you hire.

States can apply their own tests for unemployment insurance, workers' compensation and wage laws, so check your state's labor department too.

What do I need when I hire an independent contractor?

• Form W-9 from the contractor, which gives you their correct taxpayer identification number for the information return you will file (IRS: About Form W-9).
• Form 1099-NEC for each contractor you pay at or above the threshold in a year. For tax years beginning after 2025 the threshold is $2,000, and the form is due by January 31 (IRS: Instructions for Forms 1099-MISC and 1099-NEC).
• A written agreement that describes the result you are paying for, not hours you control.

You do not withhold income tax or pay payroll taxes for a true contractor; they pay their own self-employment tax.

What do I need when I hire an employee?

Hiring an employee brings payroll duties (IRS: Hiring employees):

• an Employer Identification Number, which is always free from the IRS (see how to get an EIN)
• a signed Form W-4 from each new employee when they start work
• a completed Form I-9 for every person you hire, which verifies their identity and authorization to work (USCIS: I-9)
• withholding and depositing income tax, Social Security tax and Medicare tax from wages
• federal unemployment tax (FUTA), which only the employer pays, and most employers pay state unemployment tax too (IRS: Federal unemployment tax)

Your state may also ask you to report each new hire within a set number of days and may require workers' compensation insurance; see small business insurance.

What happens if I get it wrong?

The IRS says that if you classify an employee as an independent contractor with no reasonable basis for doing so, you may be held liable for employment taxes for that worker. The Department of Labor warns that misclassified employees may not receive the minimum wage and overtime pay they are entitled to under the FLSA (DOL: Misclassification). The SBA adds that you may need to pay back taxes and penalties, provide benefits and reimburse wages.

For a new service business, the safest habit is to decide each worker's status before their first day, write down why, and revisit it if the work changes, for example if a contractor starts working set hours on your schedule with your equipment.