Employee vs Independent Contractor (W2 vs Form 1099-NEC)
One of the easiest identifiers of an employee is that they’re paid through their employer’s payroll system. The employer must also pay and report the employee’s taxes withheld. However, paying them through your payroll system and administering their taxes do not automatically make them your employee. The true test lies in whether there’s an “employment relationship” that meets legal standards.
Unlike employees, who are compensated through payroll, independent contractors are paid through the payer’s Accounts Payable (AP) system and are ultimately responsible for reporting their own income and paying their own taxes.
Similar to employees, there are legal standards for determining whether someone is an independent contractor. Because circumstances vary, it can be difficult to arrive at the right conclusion.
Generally, the biggest factor is how much control a company has over the worker.
With a W-2 worker (or employee), you have the right to control and direct their work activities. You can train them as you see fit, require that they work a certain number of hours per week, and tell them where to do the job.
With a 1099-NEC worker (or independent contractor), you can control or direct only the outcome of the work. Basically, you assign work responsibilities — including your expected deliverables — to the independent contractor and conduct limited tax reporting via Form 1099-NEC. However, you cannot control the independent contractor’s work activities or how they execute the assignment.
Legal standards for classifying employees and independent contractors:
- The Internal Revenue Service utilizes “common law” rules, which consist of three main categories: Behavioral Control, Financial Control, and Type of Relationship. See Section 2 of IRS Publication 15-A, Employer’s Supplemental Tax Guide.
- The U.S. Department of Labor (DOL) adopts the “economic reality” test for Fair Labor Standards Act purposes. See Fact Sheet 13: Employment Relationship Under the Fair Labor Standards Act (FLSA).
- The Darden factors can be applied to other federal employment laws, such as those pertaining to Equal Employment Opportunity (EEO).
- Many states have different tests for various statutes, such as employment tax, workers’ compensation, unemployment insurance, wage and hour, and EEO.
Learning the different tests and deciphering which ones are applicable to your situation can be challenging. Moreover, due to the abundance of tests, a worker can potentially be an employee under one law and an independent contractor under another law. When the lines are blurred, it’s important to consult with an employment law expert.
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