Calling someone a contractor doesn't make them one. The IRS has its own definition — and misclassifying a worker can trigger back taxes, penalties, and audits that cost far more than doing it right from the start.
The Core Difference
A W-2 employee works under your direction and control. You set their schedule, provide their tools, and direct how their work gets done. You withhold taxes from their paycheck and pay employer-side payroll taxes (Social Security, Medicare).
A 1099 independent contractor controls how their work gets done. They typically work for multiple clients, use their own tools and equipment, and are responsible for their own taxes. You pay them the full agreed amount — no withholding — and issue a 1099-NEC if you pay them $600 or more in a calendar year.
How the IRS Decides
The IRS looks at three main categories: behavioral control (do you control how the work is done?), financial control (do you control the business aspects of the worker's job?), and the type of relationship (written contracts, benefits, permanency of the relationship). No single factor is determinative — it's the overall picture that matters.
The Cost of Getting It Wrong
If you misclassify an employee as a contractor, you can be held liable for the employee's share of taxes that should have been withheld, your employer share, interest, and substantial penalties. The IRS and the Department of Labor both have enforcement programs specifically targeting misclassification.
Beyond federal exposure, Tennessee has its own employment laws that create additional liability for misclassification.
When Contractors Make Sense
Contractors are ideal for project-based work, specialized skills you need occasionally, or relationships where the person genuinely operates their own business and serves multiple clients. A graphic designer you hire for one project, a consultant who works with many companies, a freelance writer — these are natural contractor relationships.
When You Should Hire an Employee
If someone works for you consistently, follows your schedule, uses your equipment, and primarily works for your business — they're likely an employee under the law, regardless of what your contract says.
Before You Bring Anyone On
Get the classification right from the start. Use a proper independent contractor agreement that reflects a genuine contractor relationship. Our Independent Contractor Kit covers the agreement language, the documentation you need, and the ongoing practices that support contractor status — so you're protected if the classification is ever questioned.