Employees and independent contractors are distinct legal categories with fundamentally different tax treatment, labor protections, benefits eligibility, and company obligations. The IRS and Department of Labor apply multi-factor tests to determine correct classification. Misclassification (treating employees as contractors to save payroll taxes and benefits costs) carries significant penalties: back taxes, interest, fines, lawsuits, and reputational damage. It's one of the most common legal errors at growing startups.
The core distinctions:
| Dimension | Employee (W-2) | Contractor (1099) |
|---|---|---|
| Tax form | W-2 (employer withholds taxes) | 1099-NEC (no withholding) |
| Payroll taxes | Company pays half (~7.65%) | Contractor pays full ... |