1099 vs W-2: Worker Classification Made Simple
Let’s cut through the noise. You don’t pick 1099 or W-2 because it “feels right.” The law decides. Your job is to look at the facts—how the work is controlled, paid for, and structured—and then match those facts to the right bucket. Do that and you avoid surprise payroll taxes, penalties, and messy audits. Skip it and you’ll pay for it later.
I’m going to show you, in clean English, how the IRS tests status for taxes, how the Department of Labor thinks about wages and overtime, where states like California use the ABC test, and how to build a simple, repeatable process that keeps you safe. You’ll also get exact forms, deadlines, and a 30-minute setup you can run this week.
The Core IRS Test: Control, Money, Relationship
For federal tax purposes (withholding, FICA, FUTA), the IRS uses the common-law test. You look at evidence across three buckets:
Behavioral control (who directs how the work is done),
Financial control (who controls the money, tools, profit chance), and
Relationship of the parties (contracts, benefits, permanency). IRS+2IRS+2
If your company has the right to control how a person works—even if you don’t micromanage day to day—you’re leaning employee. If the worker sets methods, prices, tools, and real profit/loss opportunity, you’re leaning contractor. There’s no single magic factor. You weigh them all. IRS
The Two Rulebooks: IRS vs DOL (And Why Both Matter)
IRS = taxes. Their test decides payroll tax duties (withholding, Social Security/Medicare, FUTA). IRS
DOL (FLSA) = wages. Their test decides minimum wage/overtime and can differ from the IRS.
In January 2024, DOL finalized a multi-factor “economic reality” rule under the FLSA. In May 2025, DOL’s Wage & Hour Division issued Field Assistance Bulletin 2025-1, saying it’s reconsidering the 2024 rule and won’t enforce it for now while relying on other guidance during enforcement. Private lawsuits can still cite the 2024 rule’s framework. Translation: the enforcement posture is in flux, but wage/hour risk remains. Keep classifying carefully. DOL+3Federal Register+3DOL+3
Bottom line: Even if DOL pauses enforcement on one rule, you still face IRS exposure on taxes and possible wage/hour exposure (including private litigation). Run both lenses.
States Can Be Stricter: Meet the ABC Test
Several states use the ABC test for some or all purposes. In California (AB 5), a worker is presumed an employee unless you prove all three of these:
A) The worker is free from control and direction in the performance of the work,
B) The work is outside your usual course of business, and
C) The worker is customarily engaged in an independently established trade. Franchise Tax Board+1
That “outside your usual course of business” prong (B) trips up a lot of companies. A marketing agency hiring freelance marketers in California? That’s risky under the ABC test. Know your state’s standard before you onboard.
Don’t Forget Special Buckets: Statutory Employees & Nonemployees
The IRS recognizes four categories: independent contractor, common-law employee, statutory employee, and statutory nonemployee. Learn these edge cases so you don’t misfile payroll returns. IRS
Statutory employees (certain drivers, life insurance agents, homeworkers, traveling salespeople) are treated like employees for FICA/FUTA even if they’d look like contractors under common law. IRS+1
Statutory nonemployees (direct sellers, licensed real estate agents, certain companion sitters) are treated as self-employed if specific conditions are met (e.g., paid mainly by sales/output and a contract saying they’re not employees). IRS+1
1099 Compliance Essentials (W-9s, 1099-NEC, Backup Withholding)
Collect a Form W-9 before the first payment. No W-9 = no pay. If you don’t have a valid taxpayer ID on file (or IRS flags it), you may be required to withhold 24% as backup withholding from payments and remit it to the IRS. Use the IRS TIN Matching service to prevent mismatches. IRS+2IRS+2
File 1099-NEC by January 31. If you pay a nonemployee $600+ for services in a calendar year, file Form 1099-NEC with the IRS and furnish the worker’s copy by January 31. Don’t miss it. IRS+1
Pro tip: If you accidentally issued both a W-2 and a 1099 to the same worker for the same time period, you’ve raised a classification red flag. The IRS tells its examiners to dig in. IRS
What Misclassification Costs You
If a worker should’ve been a W-2 employee, the IRS can assess back payroll taxes (employer and sometimes employee shares), penalties, and interest. DOL or state agencies can layer on wage/overtime and unemployment insurance exposures. Don’t assume your contractor agreement saves you. Facts rule. (See IRS Pub 15/15-A for employment tax responsibilities and definitions.) IRS+1
How To Decide: A Simple, Repeatable Test
Use this quick review on every new engagement:
1) Map control (behavioral)
Do you tell the worker how to do the job, train them, set their schedule, or supervise daily? That’s employee-ish. If you buy results, not methods, you’re closer to contractor. IRS
2) Map the money (financial)
Who buys tools? Who eats overruns? Can the worker price jobs to make more or lose money? True profit/loss points to contractor. Reimbursements, hourly pay, and no risk point to employee. IRS
3) Map the relationship
Ongoing, exclusive, core to your business, with benefits? Employee. Short project, non-core, their own clients and entity? Contractor. (Mind state ABC rules.) IRS+1
4) Check special buckets
Confirm statutory categories before you decide. IRS
5) Run the state overlay
If you’re in an ABC state (e.g., CA), confirm all three prongs. If you fail B, they’re likely an employee regardless of your federal view. Labor & Workforce Development Agency
6) Document your call
Keep a one-page memo with the facts, your test results, and why you decided 1099 or W-2.
Your 30-Minute Compliance Setup (Do This Once)
Minute 0–10: Build your worker-type checklist
Include the IRS three buckets, a state ABC check, and a statutory category check. Save it as “Worker Intake.” IRS+2Franchise Tax Board+2
Minute 10–20: Lock your vendor onboarding
Require W-9 before payment. Turn on TIN Matching. Add a field for business entity type (LLC/S-corp/sole prop). Flag missing or invalid TINs for backup withholding at 24%. IRS+1
Minute 20–30: Calendar filings
Add a recurring January 10 audit of contractor totals and addresses. Add a January 31 filing reminder for 1099-NEC. Share the calendar with your bookkeeper and CPA. IRS
Contracts That Help (and What They Can’t Do)
Good contracts reflect reality: scope, deliverables, right to subcontract, tools/expenses, project timeline, and an explicit statement that the contractor runs an independent business (EIN, business insurance, multiple clients). Keep it aligned with your facts.
Bad contracts try to paper over control you actually exercise. Auditors look through documents to the real relationship. If it walks and talks like employment, it’s employment.
Red Flags That Scream “Employee”
You set hours, approve time off, and run performance reviews.
You supply the laptop, require specific software, and lock them into your workflow and tools.
The work is your core business, ongoing, and only for you. (This flunks B in the ABC test in states like CA.) Labor & Workforce Development Agency
You issued a W-2 and a 1099 to the same person for the same period.
Get 1099 vs W-2 Right in One Hour
Bring your roster. I bring the checklist.
In 60 minutes we map each role to IRS tests, write your classification policy, and build contractor/employee onboarding packets.
You leave with clear decisions, a one-page action plan, and next dates.