Employee vs. Independent Contractor: How to Classify Workers Correctly

When you bring on help, one of the first decisions is whether the person is an employee (W-2) or an independent contractor (1099). This isn't a choice you get to make based on preference; it depends on the actual working relationship.

Why it matters

Employees: you withhold income tax, pay employer payroll taxes, and in Washington you participate in workers' compensation, unemployment insurance and other state programs.

Contractors: you pay the invoice; the contractor handles their own taxes and insurance.

Misclassifying an employee as a contractor can lead to back taxes, penalties, interest and unpaid workers' compensation premiums.

The IRS approach

The IRS looks at the whole relationship, grouped into three areas:

1. Behavioral control. Does the business control how, when and where the work is done? Detailed instructions and training point toward employee status.

2. Financial control. Does the worker have their own business expenses, tools, multiple clients and the chance to make or lose money? Is the worker paid by the project rather than by the hour?

3. Relationship of the parties. Is there a written contract? Benefits? An expectation that the relationship continues indefinitely? Is the work a key part of your regular business?

Washington's rules are stricter

Washington agencies apply their own tests, which are often stricter than the IRS:

• Employment Security Department (unemployment insurance) generally treats workers as employees unless specific conditions are met, such as freedom from control and an independently established business
• Labor & Industries (workers' compensation) has its own multi-part test, and some workers who qualify as contractors elsewhere may still need coverage
• Construction has additional requirements, including contractor registration

A worker can be a contractor for the IRS and still be treated as an employee by a Washington agency.

Signs someone is likely an independent contractor

• Has their own business, business license and UBI
• Advertises services to the public and works for multiple clients
• Uses their own tools and equipment
• Sets their own hours and methods
• Invoices you and is paid by the project
• Carries their own insurance
• Is registered with Labor & Industries, if they're a construction contractor

Signs someone is likely an employee

• Works set hours you determine
• Uses your equipment, uniforms or vehicle
• Is trained by you and follows your procedures
• Works only for you, indefinitely
• Is paid hourly or salary without an invoice

Best practices if you use contractors

• Collect a W-9 before the first payment
• Use a written contract describing the deliverables, not the hours
• Verify their business license and, for construction, L&I registration
• Keep proof of their insurance
• Issue 1099-NEC forms when payments reach the threshold

The bottom line

Classification is based on how the work is actually done, and Washington applies stricter tests than the IRS. When in doubt, get advice before you start paying someone.

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Need help getting this right? TRIG Bookkeeping & Tax Services helps new business owners in Washington with company registration, monthly and annual bookkeeping, and government compliance. Contact us to talk about your business.

This article is general information, not legal or tax advice for your situation. Tax rules and fees change, so confirm current details with the IRS, the Washington Department of Revenue, or a qualified professional.