1099 vs W-2: employee vs contractor for small businesses

This is general information, not legal or tax advice. Worker classification depends on the facts of each job, and federal and state tests differ. If you’re unsure, ask an accountant or employment attorney, or use the IRS resources linked below.

1099 vs W-2 comes down to one question: is the person who helps you an employee or an independent contractor? A W-2 worker is your employee, and you withhold and pay payroll taxes for them. A 1099 worker runs their own business, and you generally just pay their invoice. For a market stall, food truck or shop taking on its first helper, getting this right affects your taxes, your paperwork and your risk.

1099 vs W-2 at a glance

Employee vs contractor: how the IRS decides

You don’t get to choose the label. The IRS looks at the actual working relationship. Its guidance on independent contractor vs employee groups the evidence into three categories.

Behavioral control

Does your business control, or have the right to control, what the worker does and how they do it? Giving detailed instructions, setting hours, training someone in your way of doing things and evaluating how they work all point toward an employee. If you tell someone to arrive at 7, wear your apron, follow your opening checklist and ring up sales on your register, that looks like employment.

Financial control

Who controls the business side of the work? Signs of a contractor include having their own significant investment in tools or equipment, unreimbursed expenses, the chance to make a profit or loss, offering services to other businesses, and being paid a flat fee per job rather than by the hour.

Type of relationship

How do you both see the relationship? The IRS looks at written contracts, whether you provide benefits like paid time off or insurance, whether the work is expected to continue indefinitely, and whether the work is a key part of your regular business. A written contract that says “independent contractor” doesn’t settle it on its own.

The IRS says there’s no magic number of factors and no single factor that decides it. You weigh the whole relationship. If you still can’t tell, either you or the worker can file Form SS-8 to ask the IRS for a determination, though the IRS notes it can take at least six months.

Examples for small sellers

These are typical patterns, not rulings. The facts of your arrangement decide it.

• Likely an employee: a weekend cashier at your market stall who works the hours you set, uses your card reader and follows your pricing.
• Likely an employee: a food truck line cook working your menu, on your truck, on your schedule.
• Likely a contractor: a photographer who shoots your product photos with their own gear, sets their own price and has other clients.
• Likely a contractor: a sign painter who letters your cart, or a bookkeeper who does books for several small businesses.

The pattern: people who do the core work of your business, under your direction, are usually employees. Independent professionals who deliver a finished job are more often contractors.

What W-2 employees mean for taxes and paperwork

When you hire an employee, the IRS page on hiring employees lists the basics:

• Form I-9 to verify they’re eligible to work in the US. Every US employer must complete one for each new hire.
• Form W-4 so you know how much federal income tax to withhold.
• Payroll taxes: withhold income tax and the employee share of Social Security and Medicare, pay the employer share, and pay federal unemployment tax. You report these on employment tax returns such as Form 941 and Form 940.
• Form W-2 at year end, showing wages and taxes withheld.
• State requirements: new hire reporting, state withholding, state unemployment insurance, and workers’ compensation insurance where your state requires it.

Publication 15 (Circular E), Employer’s Tax Guide covers the federal details. Most small owners use a payroll service so these filings happen on time. You also owe minimum wage and overtime to nonexempt employees; see our guide on full-time and part-time hours for how overtime works.

What 1099 contractors mean for taxes and paperwork

For a contractor, the paperwork is lighter:

• Form W-9 before you pay them, to get their correct name and taxpayer identification number.
• Form 1099-NEC to report what you paid them, if your payments for the year reach the reporting threshold.
• No withholding or employer payroll taxes in most cases. The contractor pays their own income and self-employment tax.

The 1099-NEC threshold recently changed. Under the IRS instructions for Forms 1099-MISC and 1099-NEC, for payments made after December 31, 2025, you generally report nonemployee compensation of $2,000 or more paid to a person in a calendar year. It was $600 for many years, and the IRS says the new amount may be adjusted for inflation starting in 2027. Check the current instructions each year before you file. Payments below the threshold are still income to the contractor, and still a business expense for you, so keep the records either way.

One more detail: card payments you receive from customers are reported to you on Form 1099-K by your payment processor. That’s a different form from the 1099-NEC you send contractors.

The risk of misclassification

Calling an employee a contractor to skip payroll taxes is the mistake to avoid. If the IRS decides a worker was really an employee, you can be liable for the employment taxes you should have withheld and paid, plus penalties and interest. The IRS offers some relief options, including a Voluntary Classification Settlement Program for businesses that want to reclassify workers going forward.

The Department of Labor has its own test for misclassification under the FLSA. It notes that misclassified employees may not receive the minimum wage and overtime they’re entitled to, which can mean back pay. The DOL has revised its guidance on this test more than once in recent years, so check the current version.

Some states use a stricter test

State law can be tougher than federal law. California is the best-known example. Since AB 5 took effect on January 1, 2020, California generally uses the ABC test for state labor and unemployment law. It starts by assuming a worker is an employee. To treat them as a contractor, the hiring business must show all three:

1. The worker is free from your control and direction in doing the work, both under the contract and in fact.
2. The work is outside the usual course of your business.
3. The worker is customarily engaged in an independently established trade or business of the same kind.

Part B is the one that catches small sellers. A barista at a coffee cart is doing the usual work of the business, so they’re very hard to treat as a contractor under an ABC test. California also has exemptions for certain occupations, and other states use ABC-style tests for some purposes, often unemployment insurance. Check your state labor or workforce agency.

A quick checklist before you hire

1. Write down what the person will do, when, where and with whose equipment.
2. Run it against the IRS three categories and your state’s test.
3. If it’s an employee, set up payroll, collect a W-4 and I-9, and register with your state.
4. If it’s a contractor, collect a W-9 before the first payment and keep their invoices.
5. If you’re unsure, treat them as an employee or get professional advice.

To budget for a new hire, try the salary calculator, and read gross vs net pay to understand withholding on a paycheck.

How SleepingFire fits in

SleepingFire doesn’t classify workers, run payroll or file 1099s or W-2s. It’s a point-of-sale app. What it does help with is the day-to-day side of having employees: each person gets their own login with a role (owner, manager or cashier) and permissions you choose, a built-in time clock records their hours, and hours and commission reports show who worked and sold what, ready to hand to your payroll provider or accountant. See staff management features.

Frequently asked questions