Contractor or Employee? How to Tell, and What Each Really Costs
Hiring a contractor can look cheaper because there's no payroll tax. But you don't get to pick the label. The law looks at how the work actually happens.
The IRS test: who controls the work
The IRS groups the evidence into three categories (IRS: Independent contractor or employee?):
- Behavioral control: do you direct how, when, and where the work is done, or train them in your methods?
- Financial control: do they invest in their own tools, set their own prices, work for other clients, and have a real chance of profit or loss?
- Relationship: is there a written contract, are there benefits, and is the work ongoing and core to your business?
No single factor decides it. If you're unsure, either party can file Form SS-8 and ask the IRS for a determination.
The Department of Labor and state tests
Minimum wage and overtime under the FLSA use an "economic reality" test: is the worker in business for themselves, or economically dependent on you? The DOL's guidance on this test has changed several times in recent years, so check the current DOL page. Some states, such as California with its ABC test, are stricter than the federal rules.
Red flags you may have an employee
- You set a fixed schedule and require them on-site.
- They work only for you, indefinitely.
- You supply all the equipment and training.
- They do the same work as someone you treat as an employee.
- You pay hourly with no real negotiation or project scope.
Comparing cost honestly
A fair comparison sets the employee's all-in cost (wage + employer taxes + workers' comp + benefits) against the contractor's full rate. Contractors charge more per hour partly because they pay 15.3% self-employment tax and cover their own overhead and downtime. Use the contractor vs employee cost calculator to find the break-even rate.
Paperwork for contractors
- Collect a Form W-9 before the first payment.
- For payments made in 2026, file Form 1099-NEC if you pay a contractor $2,000 or more in the year. The threshold was $600 through 2025 (IRS).
- Use a written agreement that matches how the work really runs. A contract alone doesn't make someone a contractor.
FAQ
What is the 1099-NEC threshold for 2026?
For payments made in 2026, you generally file Form 1099-NEC for a non-employee you paid $2,000 or more during the year, up from $600 in prior years.
Can a contract make someone an independent contractor?
No. A contract is one factor, but the IRS and DOL look at how the work actually happens: who controls it and whether the worker is in business for themselves.