Employee or contractor: settle this first
Before the offer letter, and before the interview, one question decides what you owe: is this person an employee or an independent contractor? Answer it correctly and the rest is routine paperwork. Answer it wrong, for example by calling everyone “1099” because it’s simpler, and you build up a liability that shows up the day that worker files for unemployment, gets hurt, or talks to a wage lawyer. That can mean back employment taxes plus penalties, unpaid overtime claims, benefits claims, and state penalties that in some states multiply.
- The test is control and economics, not the label. The IRS looks at behavioral control (who directs how the work is done), financial control (whose tools and expenses, and whether the worker can make or lose money), and the relationship (ongoing or project-based, benefits, exclusivity). The DOL’s economic-reality test asks whether the worker is in business for themselves. Calling someone a contractor in the contract changes nothing if the facts say employee.
- Some states are stricter. California and others use the “ABC test”: a worker is an employee unless they are (A) free from your control, (B) doing work outside your usual business, and (C) independently established in that trade. Prong B is where many “contractor” arrangements fail. A design studio that hires a “freelance designer” to do client work usually fails it.
- Then the paperwork follows the facts. A true employee gets an offer letter, W-4, I-9, payroll withholding, workers’ comp and a new-hire report. A true contractor gets a contractor agreement, a W-9 and a 1099-NEC at year end, and you have to treat them as independent in practice, not only on paper.
When it is a close call
When it is a close call, treating the worker as an employee is usually the safer choice. Agencies generally lean that way, and the costs of being wrong are lopsided: treating an employee as a contractor is expensive, while the reverse just means ordinary payroll. The checklist helps you reach a clear answer, and the playbook covers the IRS’s own determination process (Form SS-8) and the voluntary reclassification program if you are correcting past arrangements.
Hiring Pack provides self-help templates and general information. It is not legal or tax advice, it is not a law firm, and it is not a substitute for the advice of an attorney. Employment and classification law varies by state and changes over time. For borderline classifications, unionized workplaces or regulated industries, work with an employment lawyer. Facts verified July 2026.