W-2 or 1099-NEC: Which Form to Issue (2026)

The worker-side guide explains what a W-2 or a 1099 means for the person receiving it. This one is for the business deciding which to issue, which is a decision about the relationship rather than about the form. Get the relationship right and the form follows: employees get a W-2, everyone else who did work for you gets a 1099-NEC once the year's payments cross the threshold. Get it wrong in the contractor direction and the bill arrives years later with interest. Canadian employers have the same question with different forms; the T4 vs T4A guide covers it.

The test the IRS applies

Federal tax law uses the common-law test, which Publication 15-A groups into three kinds of evidence. None of them is decisive on its own; the question is where the weight of the facts falls.

Behavioral control. Do you direct how the work is done, not just what result you want? Setting hours, requiring the work be done at your premises, training the worker in your methods, specifying the sequence of tasks and evaluating how they were performed all point to employment. Giving a deadline and a specification and leaving the method to the worker points to a contractor.

Financial control. Who has money at risk? A contractor invests in their own equipment, can take a loss on a job as well as a profit, offers services to other clients, and is paid by the job or by invoice. An employee is reimbursed for expenses, paid by the hour or the pay period, and works for you.

Type of relationship. Written contracts count for something but not much. Benefits (health insurance, paid leave, a retirement plan) point to employment. So does an open-ended relationship with no project end, and work that is the core of what your business sells rather than a service to it. A restaurant's cooks are employees; the plumber who fixed its dishwasher is not.

The IRS also lists statutory employees (certain drivers, full-time life insurance agents, home workers and traveling salespeople) who get a W-2 with box 13 checked even though they would otherwise be contractors, and statutory non-employees (licensed real estate agents and direct sellers paid on output under a written contract) who get a 1099 regardless.

If you cannot tell, Form SS-8 asks the IRS to decide. Either the business or the worker can file it, the determination takes months, and it binds the IRS to the answer for that worker and others in the same position. Businesses file it less often than workers do, because a worker who files one is usually already disputing their 1099.

The other tests

The IRS test governs federal employment tax. Two other regimes can reach a different answer for the same worker. The Department of Labor applies an economic-reality test under the Fair Labor Standards Act for minimum wage and overtime; its 2024 rule is still on the books but has not been enforced since May 2025, and a replacement rule proposed on February 26, 2026 that weights control and opportunity for profit most heavily was still pending as of this writing. Several states, California, Massachusetts and New Jersey among them, use an ABC test for unemployment insurance or wage law, under which a worker is an employee unless the business proves all three of: freedom from control, work outside the usual course of the business, and an independently established trade. A worker can be a contractor for the IRS and an employee for state unemployment at the same time, and the state agency is the one more likely to find out first, because a laid-off contractor who files for benefits triggers the inquiry.

What each form commits you to

If the worker is an employee you withhold federal income tax under their W-4 and Publication 15-T, withhold 6.2% Social Security and 1.45% Medicare and match both, pay FUTA on the first $7,000 and state unemployment on the state's wage base, deposit the withheld and matched amounts on the IRS schedule your liability puts you on, file Form 941 quarterly and 940 annually, carry workers' compensation where the state requires it, keep an I-9, follow federal and state overtime and minimum-wage rules, and issue a pay stub each period where the state requires one. In January the employee gets a W-2 and the SSA gets Copy A with a W-3, by February 1, 2027 for 2026 wages. The W-2 box guide covers the form; the W-2 generator produces the employee copies.

If the worker is a contractor you collect a signed Form W-9 before the first payment, pay the invoice with nothing withheld, and, if the year's payments by cash, check, ACH or wire reach $2,000 for 2026 ($600 for 2025), issue a 1099-NEC by February 1, 2027 and file Copy A with the IRS through IRIS by the same date. Payments by card or through a platform are reported by the processor on a 1099-K, not by you. The only withholding is 24% backup withholding when the payee will not give you a TIN, remitted on Form 945. No FICA match, no FUTA, no unemployment insurance, no workers' compensation in most states, no overtime. The 1099-NEC vs 1099-MISC guide has the box-by-box; the 1099-NEC generator produces the recipient copies.

The employer-side cost of a W-2 relationship is roughly 8 to 12% of wages on top of the pay itself (7.65% FICA, FUTA, state unemployment, workers' compensation), which is exactly why the misclassification pressure runs in the contractor direction and why the IRS prices it the way it does.

What misclassification costs

If the IRS reclassifies a contractor as an employee and the treatment was not intentional, section 3509 sets the federal employment-tax liability at reduced rates: 1.5% of wages for the federal income tax you did not withhold, 20% of the employee's share of FICA you did not withhold, and your full employer share of FICA. Combined that is 10.68% of wages up to the Social Security wage base and 3.24% above it. If you did not file the 1099s the first two rates double, to 3% and 40%, for a combined 13.71% and 5.03%. Intentional disregard is assessed at the full rates: everything that should have been withheld, plus the match. On top of any of these come FUTA, interest from the original due dates, failure-to-deposit penalties, failure-to-file penalties for any quarter with no 941 on file (a business that files 941s for other staff has instead understated the wages on them, and corrects those returns), the information-return penalties for the W-2s that were never issued, and the state's own assessment for unemployment insurance and, where applicable, unpaid overtime. How far back the IRS can go depends on what you filed. If you file Form 941 for other staff, those returns start the usual three-year clock, counted from April 15 of the following year. A business that never filed a 941 has no clock at all, and every year the IRS can show the worker was an employee stays open.

The worker has a role in surfacing it. An individual who believes they were an employee can file Form 8919 with their return to pay only the employee share of FICA rather than self-employment tax, which tells the IRS who the employer was.

Two ways to fix it yourself

Section 530 relief is a safe harbor, older than the common-law regulations, that stops the IRS from reclassifying workers for employment-tax purposes when the business had a reasonable basis for contractor treatment (reliance on a court case or ruling, a prior IRS audit that did not challenge the treatment, or a long-standing recognized practice in a significant segment of the industry), treated every worker in a similar position the same way, and filed a 1099 for each of them for every year. It protects the business's past periods, not the worker's status under any other law. The reporting-consistency prong is the one small businesses lose on: a year of missing 1099s forfeits the relief for that year.

The Voluntary Classification Settlement Program is for a business that knows the answer is W-2 and wants to switch without an audit of the past. You apply on Form 8952 at least 120 days before the date you want to start treating the workers as employees. To qualify you must have filed 1099s for the workers for the previous three years and not be under an employment-tax audit or a DOL or state classification audit. The price is 10% of the section 3509 liability on the most recent year's payments to those workers, with no interest and no penalties, and the IRS agrees not to audit the classification for earlier years. For a business with $200,000 of contractor payments in the prior year that is a payment of about $2,136 to close every year before it. The workers then get a W-2 going forward, from the date in the closing agreement.

Sorting the common cases

A bookkeeper who comes in Tuesdays, works on your software, and takes direction from you on what to post: employee. A bookkeeping firm you send your receipts to: contractor. A designer you hired for a rebrand at a fixed fee who works from her own studio: contractor. The same designer on a monthly retainer, in your Slack, on your schedule, doing whatever comes up: probably employee. A nanny, caregiver or housekeeper in your home: employee, and a W-2, whatever the two of you agreed. A licensed real estate agent paid on commission: statutory non-employee, 1099. A delivery driver you supply with a route, a vehicle and a uniform: employee. A driver with their own truck who takes jobs from you and others: contractor.

When the facts are close, the safer answer for the business is W-2. The cost is a payroll percentage you can price into the pay rate; the other mistake comes due as back taxes, interest and penalties for every open year.