A W-2 employee is on your payroll. A 1099 contractor runs their own business and invoices you. The label is not a choice: it depends on how the work is actually controlled, and misclassification brings back taxes, penalties and interest.
Cost differences
- For employees, you pay the employer half of FICA (7.65%), FUTA, SUTA and workers' comp, and you withhold their income tax.
- Contractors pay self-employment tax of 15.3% on their own net earnings (Social Security portion up to $184,500 in 2026) and handle their own income tax.
- You file Form 1099-NEC for contractors paid $600 or more in a year (rising to $2,000 for payments made after 2025 under the 2025 tax law), and Form W-2 for employees.
Who counts as an employee
The IRS looks at behavioral control, financial control and the relationship between the parties. The Department of Labor applies an "economic reality" test under the Fair Labor Standards Act. Several states use the stricter ABC test, including California, Massachusetts, New Jersey and Illinois for some laws, under which a worker is an employee unless the work is outside the usual course of your business, among other conditions.
Signs a worker is an employee
- You set their hours and tell them how to do the work.
- They use your equipment and work only for you.
- The work is a core part of your business.
- The relationship is ongoing with no end date.
Practical advice
When in doubt, treat the worker as an employee or get advice from an employment attorney. You can ask the IRS for a determination with Form SS-8. Compare the full cost of a W-2 hire with the cost-to-hire calculator.