Independent Contractor or Employee? How the IRS Decides

Whether someone works for you as an employee or as an independent contractor changes your taxes, your paperwork, and your risk. The label you choose does not decide it. The facts do.

How the IRS looks at it

According to IRS Topic No. 762, you must weigh all the facts. The IRS groups them into three categories:

• Behavioral control. Does the business control what the worker does and how the worker does it, through instructions or training?
• Financial control. Does the business control the business side of the work, such as how the worker is paid, whether expenses are reimbursed, and who supplies tools?
• Relationship of the parties. How do the parties see their relationship? Look at written contracts, benefits, and whether the work is ongoing and a key part of the business.

No single fact decides it, and a signed contract that calls someone a contractor does not settle it on its own.

What you do for each type

Employees

• Collect Forms W-4 and I-9.
• Withhold income tax and employee Social Security and Medicare tax, and pay the employer share.
• Deposit the taxes and file payroll returns. See payroll tax deposits and hiring your first employee.
• Issue a Form W-2.

Independent contractors

• Collect a Form W-9 before you pay.
• Do not withhold. The contractor pays their own self-employment tax.
• Report payments on Form 1099-NEC if you meet the threshold. For payments made in 2026, the general threshold is $2,000. See our compliance update.

Why it matters

If the IRS decides a worker was an employee, the business can owe employment taxes it did not withhold or pay, along with penalties and interest. State agencies, including unemployment insurance and workers’ compensation offices, use their own tests, and these can differ from the IRS test.

If you are not sure

You or the worker can ask the IRS for an official determination on Form SS-8. It can take time, so many owners talk to a tax professional first.

Not sure how to classify a worker? Book a call with FlowTex.

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Sources

• IRS: Topic No. 762, Independent contractor vs. employee
• IRS: Instructions for Forms 1099-MISC and 1099-NEC
• IRS: Hiring employees

This article is general information, not tax or legal advice. Worker classification depends on your facts and your state’s rules.