The fundamental difference lies in the relationship and control you have over the worker. A payroll employee (also known as a W-2 employee) is a part of your company’s workforce. They are managed by you and are subject to your company’s rules, schedules, and methods of work. A 1099 contractor, on the other hand, is an independent, self-employed individual you hire for a specific project or a set period of time. You control the end result of their work, but not how or when they do it.
Why This Distinction Matters
The choice between hiring an employee or a contractor has major financial and legal implications for your business. Getting this wrong can lead to costly fines, back-taxes, and legal issues from government agencies like the IRS.
Behavioral, Financial, and Relationship Control
The IRS uses a three-part test to determine if a worker is an employee or a contractor. You can use these same questions to guide your decision-making:
- Behavioral Control: Do you provide instructions and training on how to do the job?
- Financial Control: Do you provide the tools, equipment, and resources for the job? Do you reimburse expenses?
- Relationship: Is the relationship an ongoing, permanent one, and are benefits offered?
If you answered “yes” to most of these questions, the worker is likely a payroll employee and should be treated as such to avoid misclassification risks. Sources