# People: employees and contractors

> Who controls the work decides employee or contractor. An employee gives a W-4 and an I-9 and goes through payroll; a contractor gives a W-9 and invoices.

Source: https://lopifi.com/learn/hiring-employees-and-contractors
Part of: Lopifi — US GAAP books on autopilot, checked by a CPA (https://lopifi.com)

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**Should my first hire be an employee or a contractor, and what forms do I need?** Who controls the work decides employee or contractor. An employee gives a W-4 and an I-9 and goes through payroll; a contractor gives a W-9 and invoices.

Whether someone is an employee or a contractor isn't decided by the title, the contract or what both sides would prefer. For federal tax, it's decided by who has the right to control the work. Getting it wrong means back payroll taxes, penalties and interest, owed by the company.

> “Under common-law rules, anyone who performs services for you is generally your employee if you have the right to control what will be done and how it will be done.”

— [IRS Pub. 15-A (2026), §2 — Common-Law Employees](https://www.irs.gov/publications/p15a), The common-law test: the right to control what and how

The IRS groups the evidence into three kinds (behavioral control, financial control and the type of relationship) and weighs them together. That's [worker classification](https://lopifi.com/md/glossary/worker-classification). [Hiring your first employee](https://lopifi.com/md/learn/hiring-your-first-employee) weighs them for Northwind's two hires, Priya Shah and Marcus Lee, and for the freelancer who designed the logo.

> “The keys are to look at the entire relationship and consider the extent of the right to direct and control the worker.”

— [IRS, Independent contractor (self-employed) or employee?](https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee), Behavioral control, financial control and the type of relationship

> **States can be stricter.** Some states apply an [ABC test](https://lopifi.com/md/glossary/abc-test) for some purposes, which treats more workers as employees than the federal test does. Where the person works decides which state's rule applies.

## The paperwork, by the first day

The two kinds of worker hand the company different forms. Mixing them up is a common first-hire mistake: a contractor asked for a W-4 or an employee handed a W-9 tells the IRS, and the worker, which way the company was treating them.

|  | Employee | Contractor |
| --- | --- | --- |
| Tax form they give you | [Form W-4](https://lopifi.com/md/glossary/form-w-4), so payroll withholds the right federal income tax | [Form W-9](https://lopifi.com/md/glossary/form-w-9), so you have the TIN for their 1099 |
| Work eligibility | [Form I-9](https://lopifi.com/md/glossary/form-i-9): Section 1 by the first day of work, the employer's Section 2 within three business days | None. It's the contractor's own business |
| Reported to the state | Yes, [new-hire reporting](https://lopifi.com/md/glossary/new-hire-reporting) to the state's registry | No |
| Paid through | Payroll, with income tax and FICA withheld and the employer's share on top | Accounts payable, against an invoice, with nothing withheld unless [backup withholding](https://lopifi.com/md/glossary/backup-withholding) applies |
| Year-end form you give them | [Form W-2](https://lopifi.com/md/glossary/form-w-2), by February 1, 2027 for 2026 wages | [Form 1099-NEC](https://lopifi.com/md/glossary/form-1099-nec) if paid $2,000 or more in 2026, by the same day |

What each kind of worker gives the company, and when. Federal rules; states add their own.

> “Complete Form W-4 so that your employer can withhold the correct federal income tax from your pay.”

— [Form W-4 (2026)](https://www.irs.gov/pub/irs-pdf/fw4.pdf) (PDF), Form W-4, Employee's Withholding Certificate

> “Employees must complete and sign Section 1 of Form I-9 no later than the first day of employment, but not before accepting a job offer. … Employers or their authorized representative must complete and sign Section 2 within three business days after the employee's first day of employment”

— [USCIS Form I-9 (Edition 01/20/25), Sections 1 and 2](https://www.uscis.gov/sites/default/files/document/forms/i-9.pdf) (PDF), Form I-9, Employment Eligibility Verification

— [Form W-9 (Rev. 3-2024)](https://www.irs.gov/pub/irs-pdf/fw9.pdf) (PDF), Form W-9, Request for Taxpayer Identification Number and Certification

> “For tax years beginning after 2025, the minimum threshold amount for reporting certain payments required to be reported on certain information returns and/or perform backup withholding on those payments increased to $2,000 and may be adjusted for inflation beginning in calendar year 2027. … Section 6071(c) requires you to file Form 1099-NEC on or before January 31, using either paper or electronic filing procedures.”

— [Instructions for Forms 1099-MISC and 1099-NEC (12/2026), What's New and Filing dates](https://www.irs.gov/instructions/i1099mec), Form 1099-NEC: the $2,000 threshold and the January 31 deadline

The onboarding itself, in order and on Northwind's real dates, is [Hiring your first employee](https://lopifi.com/md/learn/hiring-your-first-employee). Vendors and contractors are [vendor onboarding: W-9 and TIN matching](https://lopifi.com/md/learn/vendor-onboarding-w-9-and-tin-matching).

**Exercise — Which form, from whom?.** Northwind is hiring its first employee and its first contractor in the same week. Pick the form each row needs. One form appears twice, and one row isn't something a person hands you at all. Type it in the workbook at https://lopifi.com/playground.

## What a paycheck puts on the books

Northwind's first payroll, for Priya Shah and Marcus Lee, ran on September 25, 2026: $8,400 of gross wages. $6,707.40 reached the staff's bank accounts. The other $1,692.60 was withheld (federal income tax and the employees' share of Social Security and Medicare) and is owed to the Treasury. On top, Northwind owes its own matching share, $642.60. Both sit in [payroll liabilities](https://lopifi.com/md/glossary/payroll-liabilities) until they're deposited. [Gross to net pay](https://lopifi.com/md/learn/gross-to-net-pay) works each paycheck, and [recording payroll](https://lopifi.com/md/learn/recording-payroll-journal-entries) posts it.

*[Journal entries: JE-11, AJE-4]*

JE-11 and AJE-4: September's payroll and the employer's share.

> “The federal income tax and employees’ share of social security and Medicare taxes that you withhold from your employees’ paychecks are part of their wages that you pay to the U.S. Treasury instead of to your employees. Your employees trust that you pay the withheld taxes to the U.S. Treasury by making federal tax deposits. This is the reason that these withheld taxes are called trust fund taxes.”

— [IRS Publication 15 (2026), Circular E — Introduction](https://www.irs.gov/publications/p15), Withheld payroll taxes are the government's money, held in trust

**Wrong:** Call the first hire a contractor to skip payroll for now, and sort it out after the round.

**Right:** Before the first day, decide from the three categories. If it's an employee, run them through payroll with a W-4 and an I-9. If it's a contractor, collect a W-9 and pay their invoices.

The title and the contract are evidence, not the answer. If the company controls what is done and how, the person is generally an employee.

> **Classification is decided by control, not by the contract. The forms follow from it: W-4 and I-9 for an employee, W-9 for a contractor.**

Where this goes next: [the Payroll track](https://lopifi.com/md/learn/payroll) runs this payroll end to end, from [gross to net](https://lopifi.com/md/learn/gross-to-net-pay) through [deposits](https://lopifi.com/md/learn/payroll-tax-deposits) and [the 941](https://lopifi.com/md/learn/payroll-tax-returns). [1099-NEC and 1099-MISC at year end](https://lopifi.com/md/learn/1099-nec-and-1099-misc-at-year-end) covers the contractors, and [whether a startup has to offer health insurance](https://lopifi.com/md/learn/does-a-startup-have-to-offer-health-insurance) starts the benefits.

## Where this lesson's rules come from

- [IRS Pub. 15-A (2026), §2 — Common-Law Employees](https://www.irs.gov/publications/p15a) — The common-law test: the right to control what and how (irs)
- [IRS, Independent contractor (self-employed) or employee?](https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee) — Behavioral control, financial control and the type of relationship (irs)
- [Form W-4 (2026)](https://www.irs.gov/pub/irs-pdf/fw4.pdf) (PDF) — Form W-4, Employee's Withholding Certificate (form)
- [USCIS Form I-9 (Edition 01/20/25), Sections 1 and 2](https://www.uscis.gov/sites/default/files/document/forms/i-9.pdf) (PDF) — Form I-9, Employment Eligibility Verification (form)
- [Wikipedia, “Form I-9”](https://en.wikipedia.org/wiki/Form_I-9) — Form I-9 (reference)
- [Form W-9 (Rev. 3-2024)](https://www.irs.gov/pub/irs-pdf/fw9.pdf) (PDF) — Form W-9, Request for Taxpayer Identification Number and Certification (form)
- [IRS Pub. 15 (2026), Hiring New Employees — New hire reporting](https://www.irs.gov/publications/p15) — Every new employee is reported to the state (irs)
- [Instructions for Forms 1099-MISC and 1099-NEC (12/2026), What's New and Filing dates](https://www.irs.gov/instructions/i1099mec) — Form 1099-NEC: the $2,000 threshold and the January 31 deadline (irs)
- [IRS Publication 15 (2026), Circular E — Introduction](https://www.irs.gov/publications/p15) — Withheld payroll taxes are the government's money, held in trust (tax)

## Read further

- https://lopifi.com/md/journal-entries/payroll
- https://lopifi.com/md/startups/contractor-vs-employee
- https://lopifi.com/md/startups/collecting-w9s-and-backup-withholding
- https://lopifi.com/md/startups/form-1099-nec-for-startups
- https://lopifi.com/md/startups/payroll-journal-entries
- https://lopifi.com/md/accounting/worker-classification
- https://lopifi.com/md/accounting/1099-nec

- **Track:** [Back office core](https://lopifi.com/md/learn/core)
- **Lesson:** Lesson 5 of 9 — 10 min
- **Terms taught:** [Worker classification](https://lopifi.com/md/glossary/worker-classification), [ABC test](https://lopifi.com/md/glossary/abc-test), [Form W-4](https://lopifi.com/md/glossary/form-w-4), [Form I-9](https://lopifi.com/md/glossary/form-i-9), [New-hire reporting](https://lopifi.com/md/glossary/new-hire-reporting), [Form W-9](https://lopifi.com/md/glossary/form-w-9), [Form 1099-NEC](https://lopifi.com/md/glossary/form-1099-nec), [Backup withholding](https://lopifi.com/md/glossary/backup-withholding), [Payroll liabilities](https://lopifi.com/md/glossary/payroll-liabilities)
- **Previous:** [The books, in one lesson, Core · Lesson 4](https://lopifi.com/md/learn/how-startup-books-work)
- **Next:** [Money in and money out, Core · Lesson 6](https://lopifi.com/md/learn/money-in-and-money-out)
- **The course:** https://lopifi.com/md/learn