Hiring your first worker is an important step for a growing business. One of the first decisions you may need to make is whether the person should be hired as an employee or an independent contractor.

The distinction matters for more than payroll. Worker classification affects federal tax withholding, Social Security and Medicare taxes, unemployment taxes, reporting requirements, and the business's potential liability if a worker is incorrectly classified.

The IRS does not determine classification simply by looking at what the worker is called or how the business pays them. Instead, the entire working relationship must be evaluated.

Employee vs. Independent Contractor: What Should You Consider?

When evaluating a worker's status, ask questions such as:

Does the business have the right to control how the worker performs the job?

Does the business provide instructions about when, where, and how the work should be performed?

Does the business provide the worker's tools, equipment, or supplies?

Does the worker have significant unreimbursed business expenses?

Can the worker offer services to other businesses?

Is the relationship expected to continue indefinitely?

Does the worker perform services that are a key part of the company's regular business?

Does the business provide employee-type benefits?

Is the worker paid based on hours or wages, or does the worker have the opportunity to make a profit or experience a loss?

These questions can provide useful context, but there is no specific number of factors that automatically makes someone an employee or contractor. The IRS evaluates the complete relationship and the degree of control and independence involved.

The Three Main IRS Categories

The IRS generally considers evidence in three broad categories when determining worker classification.

1. Behavioral Control

Behavioral control looks at whether the business has the right to direct what the worker does and how the work is performed.

Evidence may include:

Instructions about how to perform the work

Required schedules or procedures

Training provided by the business

Direction regarding where work must be performed

Detailed instructions about the methods used to complete the job

The more control a business has over the details of the work, the more likely the worker may be classified as an employee.

2. Financial Control

Financial control focuses on the business aspects of the worker's relationship with the company.

Consider factors such as:

Who provides tools and equipment

Whether the worker has significant unreimbursed expenses

How the worker is paid

Whether the worker can realize a profit or suffer a loss

Whether the worker makes services available to other customers

The worker's investment in equipment or facilities

An independent contractor generally has greater independence over these business decisions.

3. Type of Relationship

The IRS also considers how the business and worker view their relationship.

Relevant factors can include:

Written contracts

Employee benefits

The expected duration of the relationship

Whether the services are a key part of the company's regular business

A contract calling someone an "independent contractor" does not automatically establish contractor status. The actual working relationship is more important than the label used in the agreement.

Tax Responsibilities When You Hire an Employee

When a worker is classified as an employee, the employer generally has payroll tax responsibilities.

These can include:

Federal income tax withholding

The employer generally withholds federal income tax from the employee's wages based on the employee's Form W-4 and applicable withholding rules.

Social Security and Medicare taxes

Employers generally withhold the employee's share of Social Security and Medicare taxes and pay a matching employer share. For 2026, the Social Security tax rate is 6.2% for both the employee and employer, while the Medicare tax rate is 1.45% for each.

Federal unemployment tax

Employers may also be responsible for FUTA tax. The standard FUTA rate is generally 6% of the first $7,000 of wages paid to each employee, before applicable state unemployment tax credits.

State and local obligations

Depending on where the business and employee are located, the employer may also have state and local payroll tax, unemployment insurance, workers' compensation, and other requirements.

Employee Tax Forms

Employees generally receive a Form W-2, Wage and Tax Statement, showing their wages and applicable tax withholding.

Employers generally must furnish Form W-2 to employees and file it with the Social Security Administration by January 31 following the calendar year being reported.

Employers may also have to file employment tax returns such as Form 941 and Form 940 and make payroll tax deposits according to the applicable deposit schedule.