1099 vs W-2 classification

The IRS distinguishes between W-2 employees and 1099 independent contractors based on the degree of control the company has over the worker. The classification has major implications for taxes, benefits, liability, and labor law compliance.

W-2 employees: the company withholds income tax, Social Security, and Medicare from each paycheck; pays employer-side payroll taxes (matching SS/Medicare, FUTA, SUTA); provides benefits as required (workers comp, unemployment insurance, ACA-mandated health insurance for larger employers); controls when, where, and how work is performed; has hire/fire authority. The default for most service-business workers.

1099 contractors: self-employed individuals or businesses providing service. They handle their own taxes (self-employment tax including both employee and employer portions of SS/Medicare); provide their own equipment, set their own schedules, control their work methods; may serve multiple clients; have separate business identity. Common in service businesses for: subcontractors handling overflow work, specialty work (e.g., bringing in an electrician for an HVAC project's electrical scope).

Misclassification is a major IRS enforcement priority. Treating a W-2-equivalent worker as a 1099 to avoid payroll taxes and benefits creates significant back-tax liability, penalties, and potential legal action. The IRS uses a 20-factor test (now consolidated into common-law factors) to determine proper classification. When in doubt, default to W-2; the cost difference is usually less than the misclassification risk.