W-2 or 1099? How to Classify Your Workers (and Stay Out of Trouble)

Hiring your first team member or adding a new contractor is a major milestone for any business owner. Whether you’re bringing on a summer intern, virtual assistant, part-time bookkeeper, or freelance designer, getting the help you need is a clear sign of growth.

But before you send that first payment, there’s a crucial compliance issue you can’t afford to overlook:

Should your worker be classified as a W-2 employee or a 1099 independent contractor?

Misclassifying workers is one of the most common tax mistakes small business owners make—and one that can lead to IRS penalties, back taxes, and potential legal consequences. This guide breaks down how to make the right classification call and what steps you should take to stay compliant.

What’s the Difference Between a W-2 Employee and a 1099 Contractor?

The distinction comes down to control—how much control you have over how, when, and where the work is done.

W-2 Employee

• You control how the work is performed, including schedule, tools, and methods

• You provide training and resources

• You’re responsible for withholding taxes, issuing a W-2, and complying with labor laws

• May require workers’ compensation and unemployment insurance

• Examples: receptionist, assistant, in-house marketing staff

1099 Independent Contractor

• Operates independently and controls their own workflow

• Provides their own equipment and often works with multiple clients

• No tax withholding—you just pay them and issue a 1099-NEC

• Examples: freelance designer, marketing consultant, contract bookkeeper

How the IRS Determines Worker Classification

The IRS uses three main categories to assess classification:

1. Behavioral control – Do you direct how and when the work is done?

2. Financial control – Do you set the rate or reimburse expenses?

3. Type of relationship – Is the work ongoing and integral to your business?

Here’s a simple comparison to help:

Still not sure? You can file IRS Form SS-8 to request a determination, but we often recommend using a mix of common sense and professional guidance.

The Real Risk of Misclassifying a Worker

It may be tempting to classify everyone as a contractor to avoid payroll setup or employment taxes—but that shortcut can come with serious consequences.

Even if your contract says someone is a contractor, the IRS will look at the actual working relationship.

You could face:

• Back taxes for Social Security, Medicare, and unemployment

• Penalties and interest for late or missing payments

• Legal claims for wages, benefits, or wrongful termination

If it walks like an employee and talks like an employee… the IRS will treat them like one.

When You Don’t Need to File a 1099-NEC

You must issue a 1099-NEC to independent contractors paid $600 or more—with a few exceptions:

• Payments to corporations (C-Corps or S-Corps) generally don’t need a 1099—unless for legal services

• Payments through platforms like PayPal or Venmo Business don’t require a 1099-NEC if the platform issues a 1099-K

• IRS 1099-K reporting thresholds are changing:

  • $5,000 in 2024

  • $2,500 in 2025

  • $600 starting in 2026

• Payments under $600 do not require reporting

• Employee wages are always reported on a W-2, not a 1099

Pro Tip: Always collect a completed Form W-9 before issuing payment. It tells you whether the payee is a sole proprietor or corporation—and helps you stay compliant.

Onboarding Checklist: W-2 vs. 1099

Once you’ve correctly classified your worker, make sure to set them up the right way from the start.

For 1099 Independent Contractors:

• Collect Form W-9 before payment

• Track payments in your accounting system

• Issue Form 1099-NEC in January if you paid them $600+

• Use a contract that outlines project scope and independent relationship

For W-2 Employees:

• Set up payroll through a provider (we use ADP®)

• Withhold and remit federal and state payroll taxes

• Provide onboarding docs (W-4, I-9, employee handbook, etc.)

• Track hours and compensation properly

Need Help with Worker Classification? Here’s Our Advice:

Don’t guess—and definitely don’t “Google and go.” Every working relationship is unique, and mistakes can be costly.

At our firm, we help small business owners:

• Review working relationships for proper classification

• Assist with onboarding, contracts, and documentation

• Set up payroll solutions and streamline compliance with tools like ADP®

Let’s Get It Right the First Time

Hiring help should make your life easier, not harder. With the right classification and a solid onboarding system in place, you’ll be on the right track to growth—with clean books and no surprises from the IRS.

Need support with 1099 compliance or employee setup?
We’re here to help—reach out to get started.