Employees vs independent contractors: the IRS rules
Calling someone a contractor does not make them one. The IRS looks at the whole relationship. Here is how the test works, what you must file for each type of worker, and what happens if you get it wrong.
Prepared by Prem Tax and Accounting Corp. Last checked against official sources on October 21, 2026.
The IRS test: who has the right to control?
The IRS uses the common-law rules. It looks at the evidence of control and independence in three categories. No single factor decides, and there is no magic number of factors. Weigh them all, and write down your reasons.
| Category | What the IRS asks | Points toward employee | Points toward contractor |
|---|---|---|---|
| Behavioral control | Do you have the right to direct how the worker does the job? | Instructions about when, where and how to work, detailed instructions, training on your methods, evaluation of how the work is done | Few instructions, you judge only the result, no training |
| Financial control | Do you control the business side of the job? | A regular wage for a period of time, you provide tools and reimburse expenses, no chance of loss | A flat fee for the job, the worker has unreimbursed expenses and a chance of profit or loss, and offers services to the market |
| Type of relationship | How do you and the worker see the relationship? | Benefits such as insurance or paid leave, an ongoing relationship, work that is a key part of your business | A specific project or period, no benefits, work separate from your core activities |
Corporate officers who work in the business are employees. Remote workers are employees if you have the right to control what is done and how, even if they choose to work remotely. There are also "statutory" categories: see Publication 15-A.
What you must do for each
| Employee | Independent contractor | |
|---|---|---|
| Before paying | Get a Form W-4. (Employment eligibility is checked on Form I-9, which is not an IRS form.) | Get a Form W-9 with the contractor's name and taxpayer identification number. |
| Taxes | Withhold income tax and the employee share of Social Security and Medicare, pay the employer share, and pay federal unemployment tax (FUTA). Make the deposits on time. | No withholding, unless backup withholding applies (24%) because the contractor did not give a taxpayer identification number. The contractor pays their own self-employment tax. |
| Returns | Form 941 each quarter, Form 940 each year, and Forms W-2 and W-3 by January 31. | Form 1099-NEC (with Form 1096 on paper) by January 31, if you paid $2,000 or more in 2026. |
| Records | Payroll records for at least 4 years. | The Form W-9, invoices and a copy of the Form 1099-NEC. |
| Also | Illinois withholding, unemployment insurance contributions and workers' compensation rules apply. | Ask the contractor for their own insurance and keep a written agreement describing the work. |
If you get it wrong
- If you treat an employee as a contractor and have no reasonable basis, you can be liable for the employment taxes you should have withheld and paid, with penalties and interest (see section 3509).
- Section 530 relief can remove the employment tax liability if you had a reasonable basis, filed all required returns consistently with your treatment, and did not treat similar workers as employees. It relieves the tax; it does not make the worker a contractor.
- Form SS-8: you or the worker can ask the IRS for an official ruling on the worker's status. It can take at least six months.
- Voluntary Classification Settlement Program (VCSP): a program to reclassify workers as employees going forward, with partial relief. You pay 10% of the employment tax that would have been due on the workers' pay for the most recent year, under reduced rates, with no interest or penalties on that amount and no employment tax audit of the earlier years for those workers. You must have filed all required Forms 1099 for the workers for the previous three years and cannot be under an employment tax audit. You apply on Form 8952.
- Workers who believe they were misclassified can report their share of uncollected Social Security and Medicare tax on Form 8919.
Illinois: a stricter test for unemployment insurance
For Illinois unemployment insurance, a worker is treated as an employee unless the business proves all three of these (Illinois Unemployment Insurance Act, section 212):
- The worker is free from control or direction over the work, both under the contract and in fact.
- The work is outside the usual course of your business, or is performed outside all of your places of business.
- The worker is engaged in an independently established trade, occupation, profession or business.
A worker can be a contractor under the IRS test and still be an employee for Illinois unemployment insurance. Other state laws have their own tests, so check before you decide.
Before you hire a contractor
- Write down the work and the result you are paying for, not hours and methods.
- Collect a Form W-9 first.
- Let the contractor use their own tools, set their own schedule and work for others.
- Do not train them on your methods or give them benefits you give employees.
- Keep invoices, and pay for the project, not a regular wage.
- Ask us if the same worker has been "temporary" for years.
Owners who work in their own corporation are covered on our S corporation owner pay page. For payroll set-up see our payroll services.
Common questions
Can we agree in a contract that the worker is a contractor?
No. A contract can say it, but that alone does not decide the worker's status, and the IRS does not have to follow it. How the parties actually work together decides.
Is a part-time worker an employee?
It can be either. It does not matter whether the work is full time or part time, or what the worker is called. What matters is whether you have the right to control what is done and how.
What is the Form 1099-NEC threshold now?
$2,000 for payments made after December 31, 2025. It was $600 before. The $2,000 amount is adjusted for inflation starting in 2027.
Do I send a Form 1099-NEC to a corporation?
Payments to a corporation for services are generally not reported, with exceptions such as attorney fees. Check the instructions before you skip a form.
Can the IRS decide for me?
Yes. Either the business or the worker can file Form SS-8, and the IRS will review the facts and make an official determination. It can take at least six months.
Official sources
- IRS: Independent contractor (self-employed) or employee?
- IRS: Behavioral control
- IRS: Financial control
- IRS: Type of relationship
- IRS Publication 15 (2026): Employer's tax guide
- IRS Publication 15-A: Employer's supplemental tax guide
- IRS: About Form SS-8, determination of worker status
- IRS: Voluntary Classification Settlement Program (VCSP)
- IRS Publication 1976: Section 530 employment tax relief requirements
- IRS: Form 1099-NEC and independent contractors (FAQ)
- Illinois Department of Employment Security: Unemployment Insurance Act (section 212)
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