Hiring your first contractor: 1099 or W-2, and the risk of guessing

The first time you pay someone to help, you face a question with a wrong answer that costs real money: are they a contractor or an employee?

The critical thing to understand up front is that this is not a choice. It is a determination based on how the working relationship actually operates. You cannot make someone a contractor by calling them one, by having them sign an agreement saying so, or by both of you preferring it that way.

Why it matters

Hiring a contractor: you pay the agreed amount. They handle their own taxes. You issue a 1099-NEC if you paid them $2,000 or more in the year — a threshold that rose from $600 for payments made from 1 January 2026. Your obligations end there.

Hiring an employee: you withhold income tax, withhold their half of Social Security and Medicare, pay the employer half yourself, pay federal and state unemployment tax, run payroll, file quarterly returns, and issue a W-2.

An employee costs roughly 10–15% more than the same money paid to a contractor, before the administrative burden.

That gap is exactly why misclassification is tempting, and exactly why it is policed.

The three categories

The IRS looks at the whole relationship across three areas. No single factor decides it.

Behavioural control

Do you control how the work is done, or only what the result must be?

Pointing toward employee: you set their hours, you require them to work at your location, you dictate the sequence and methods, you provide detailed training in how you want things done, you supervise them day to day.

Pointing toward contractor: they decide when and how, they use their own methods, you specify the deliverable and the deadline and little else.

Financial control

Pointing toward employee: you provide the tools and equipment, you reimburse their expenses, they have no opportunity for profit or loss, you pay them hourly on a regular schedule.

Pointing toward contractor: they supply their own equipment, they carry their own unreimbursed costs, they can profit or lose on a job, they invoice per project, and they work for other clients.

Type of relationship

Pointing toward employee: the arrangement is open-ended, you provide benefits, and the work is central to what your business does.

Pointing toward contractor: there is a written contract for a defined project, no benefits, and the work is peripheral to your core business.

That last point carries real weight. A design agency hiring designers to do client design work is on much shakier ground than the same agency hiring a bookkeeper.

The clearest signals

If you are unsure, these are the ones that decide most cases in practice:

Almost certainly a contractor — they have other clients, they set their own hours, they use their own equipment, they invoice per project, and they can subcontract the work.

Almost certainly an employee — you are their only source of income, you set their schedule, you provide the equipment, they work at your premises, and the arrangement has no end date.

The single most telling question: could they send someone else to do this work? A contractor generally can. An employee cannot.

What it costs to get wrong

If a worker is reclassified as an employee, you can become liable for:

• The income tax you should have withheld
• Both halves of Social Security and Medicare
• Federal and state unemployment tax
• Penalties and interest on all of it
• Possibly state-level wage, overtime and benefit claims

Note that these are retroactive across the whole relationship. On someone paid $50,000 a year for two years, the exposure runs well into five figures.

Reclassification is usually triggered by the worker themselves — filing Form SS-8 to ask the IRS to determine their status, typically after a relationship ends badly, or by applying for unemployment benefits they were never eligible for as a contractor.

There is a relief provision, Section 530, which can protect you if you had a reasonable basis for the classification, treated all similar workers consistently, and filed all the required 1099s. Consistency and filing the forms genuinely matter.

Your obligations with a contractor

Assuming they really are one:

Collect a W-9 before you pay them. Not after. Chasing a tax ID from someone who has already been paid and moved on is unpleasant, and you need it to file.

Issue Form 1099-NEC by January 31 if you paid the contractor at or above the threshold during the year for services. Copies go to the contractor and to the IRS.

The threshold changed, and 2026 is the first year it applies: $600 for payments made during 2025, which is what the forms due in January 2026 used, and $2,000 for payments made from 1 January 2026, which is what the forms due in January 2027 will use. It is indexed for inflation from 2027 onward. The $600 figure had been fixed since 1954, so it will keep appearing in guidance, software defaults and accountants’ checklists for years. If you are filing for two different years at once, check which year each payment fell in before deciding whether a form is needed.

Payments through a card or platform are different. If you paid via credit card, PayPal or a similar third-party network, the platform reports it on a 1099-K and you should not issue a 1099-NEC. Issuing one anyway causes the income to appear twice on their return — which they will then have to explain.

Deduct the payments on Schedule C line 11, contract labour.

Corporations generally do not need a 1099 — but attorneys do regardless of structure, which is a common oversight.

States are stricter than the IRS

Several states apply an “ABC test” that is considerably harder to satisfy than the federal factors. Under it a worker is an employee unless all three hold:

• A — free from your control and direction in performing the work
• B — the work is outside your usual course of business
• C — they are independently established in that trade

Prong B is the difficult one. It means a business cannot treat someone as a contractor to do the very thing the business does, regardless of how independent the arrangement looks.

If you are in a state that applies this test, the federal analysis is not sufficient. Check your state’s rules before the first payment.

The practical advice

For genuinely peripheral, project-based work from someone with other clients, a contractor relationship is straightforward and defensible.

For anyone doing core work, on your schedule, exclusively for you, indefinitely — they are an employee, and treating them otherwise is a liability you are carrying without pricing.

If it is genuinely ambiguous and the amounts are large, an hour with an employment lawyer costs far less than a reclassification.

Whatever you decide, contractor payments reduce your net profit — and the calculator below shows what that profit costs you in self-employment and income tax.