Before someone begins working with our company, it's important to understand whether they will be classified as an employee or an independent contractor (1099). This classification affects taxes, benefits, work expectations, and legal responsibilities.
What is an employee
An employee works under the direction and control of the company.
Typically, the company:
- Sets work schedules and hours
- Determines how work should be completed
- Provides ongoing supervision and training
- Supplies necessary tools and resources (when applicable)
- Pays wages through payroll with taxes withheld
Employees may be:
- Full-time
- Part-time
- Seasonal
Employees may receive
- Health insurance
- Paid time off (PTO)
- Sick leave
- Retirement benefits
- Workers' compensation coverage
What is an independent contractor (1099)?
An independent contractor is a self-employed professional who provides services for an agreed-upon project or time period.
Independent contractors control:
- When they work
- How they complete the work
- Their own business operations
Contractors are responsible for paying their own taxes and generally do not receive employee benefits.
Examples include:
- Consultants
- Fractional service providers
Employee vs. contractor at a glance
| Employee | Independent Contractor |
|---|---|
| Company controls work schedule | Sets own schedule |
| Company directs how work is completed | Decides how work is completed |
| Paid through payroll | Paid by invoice or contract |
| Taxes withheld by employer | Pays own taxes |
| Eligible for company benefits | Not eligible for employee benefits |
| Long-term employment relationship | Usually project-based or temporary |
| Receives a W-2 | Completes a W-9 and typically receives a 1099-NEC |
How worker classification is determined
The IRS determines whether a worker is an employee or an independent contractor by considering the entire working relationship. No single factor determines classification.
1. Behavioral control
Who controls how the work gets done?
Examples include:
- Instructions on how, when, or where to work
- Required training
- Direction on tools, equipment, or work methods
2. Financial control
Who controls the financial aspects of the work?
Examples include:
- Investment in tools or equipment
- Unreimbursed business expenses
- Opportunity for profit or loss
3. Relationship between the parties
How do the worker and business view their relationship?
Examples include:
- Written contracts
- Employee benefits
- Nature and length of the working relationship
The IRS considers all of these factors together when determining worker classification.
Taxforms
Employees
Complete:
- Form W-4
Receive:
- Form W-2 at year-end
Taxes are withheld from each paycheck.
Independent contractors
Complete:
- Form W-9
May receive:
- Form 1099-NEC for reportable compensation
Contractors are responsible for paying:
- Federal income tax
- Self-employment tax
- Applicable state taxes
Risks of misclassification
Incorrectly classifying a worker can lead to:
- IRS penalties
- Back taxes
- Wage and hour claims
- Benefit disputes
- Compliance issues
Worker classification should always be carefully evaluated using applicable federal, state, and local laws.
FAQs
Can a contractor set their own hours?
Yes. Independent contractors generally determine when and how they complete their work.
Do contractors receive company benefits?
No. Contractors typically are not eligible for employee benefits such as health insurance, paid time off, or retirement plans.
Who pays taxes for a contractor?
Independent contractors are responsible for paying their own federal, state, and self-employment taxes.
Can a contractor work for multiple companies?
Yes. Independent contractors are generally free to provide services to multiple clients.
Key takeaway
Choosing between an employee and an independent contractor depends on the nature of the work and the level of independence involved. Employees work under the company's direction and receive wages and benefits through payroll. Independent contractors operate as self-employed professionals, control how they perform their work, and manage their own taxes and business operations.
When in doubt, consult Human Resources or a qualified legal or tax professional before determining worker classification.
Mercury Payroll helps businesses manage payroll and related administrative tasks. Mercury does not provide legal, tax, accounting, or investment advice and does not act as your employer, professional employer organization (PEO), employer of record (EOR), or plan fiduciary. You remain responsible for your legal and regulatory obligations, including worker classification, wage-and-hour requirements, tax withholding and reporting, and benefits eligibility.