Startup Law
Is my first hire a contractor or an employee?
Whether a worker is a contractor or an employee depends on control and economic reality, not on the label you use — and getting it wrong is expensive. A genuine independent contractor controls their own schedule, tools, and methods and can work for others; if you direct how and when the work is done, the worker is more likely an employee. Different federal-tax, federal-wage, and state-law tests can apply to the same person, so a worker may be classified differently under each. Misclassification can mean back payroll taxes, unpaid overtime, and state penalties.
Is my worker a contractor or an employee?
It depends on control and economic reality, not on what you call them or whether they asked for 1099 treatment — if you control how, when, and where the work is done, the worker is probably an employee.
The IRS uses a common-law right-to-control test; the U.S. Department of Labor uses an economic-reality test under the Fair Labor Standards Act.
Why is the federal standard a moving target right now?
The federal independent-contractor rule has been in flux — the Department of Labor issued a 2024 final rule (economic-reality test), and published a new proposed rule on Employee or Independent Contractor Status in February 2026 — so the controlling test depends on timing.
Confirm the current federal rule before relying on it; and remember that some states use stricter tests.
What does misclassification cost?
Treating an employee as a contractor can expose you to back payroll taxes, unpaid overtime and minimum wage, unpaid benefits, and federal and state penalties — sometimes with personal liability.
Misclassification is one of the most common and costly early-stage mistakes.
What stricter state tests should I know about?
Several states use an 'ABC test' that presumes a worker is an employee unless the company proves all three statutory factors, which is much harder to satisfy than the federal test.
If you operate or hire across states, more than one test can apply at once — analyze each separately, because the same worker can be classified differently under federal-tax, federal-wage, and individual state standards.
What should every hire sign?
Whether employee or contractor, each person should sign an agreement that includes a written IP assignment; employees also get an offer letter and any equity grant, and contractors get a contractor agreement with assignment and confidentiality.
Without a signed IP assignment, the worker can own what they create. See the IP page.
Talk to a startup attorney
About to make your first hire across one or more states? Classify correctly and paper it right the first time. 5-minute triage: (773) 777-9888.
Frequently asked questions
Can I pay my first developer as a 1099 contractor while pre-revenue?
Only if the person is genuinely an independent contractor — setting their own hours, using their own tools, and free to work for others. If you direct how and when they work, they are likely an employee regardless of budget, and misclassifying to save money can be very costly.
What is the current federal test?
It has been in flux — a 2024 Department of Labor final rule and a new proposed rule on independent-contractor status published in February 2026 — so the controlling standard depends on the date; confirm the current rule before relying on it. The IRS right-to-control test also applies for tax purposes.
What is the ABC test?
A stricter state-law standard that treats a worker as an employee unless the business proves all three factors: the worker is free from control, performs work outside the company's usual business, and is independently established in that trade. It is much harder to satisfy than the federal test.
What is the tax difference between W-2 and 1099?
For an employee (W-2) you withhold income tax and pay the employer share of payroll taxes and unemployment; for a contractor (1099) you generally do not withhold, and the worker handles their own taxes. Misclassifying shifts costs and liability and can trigger penalties.
Do I need an employee handbook?
Not legally required to start, but basic written policies — at-will status, anti-harassment, leave, and confidentiality — reduce risk as you hire. What matters most early is correct classification, proper wage practices, and signed IP assignments.
Do contractors need to sign an IP assignment?
Yes — this is critical. Without a written assignment, a contractor generally owns the copyright in what they create for you, even after you pay them. Every contractor agreement needs an explicit IP assignment. See the IP page.
More in Startup Law
- Startup Law — overview and all topics
- LLC or Delaware C-Corp for a Startup?
- The 83(b) Election
- Co-Founder Equity Splits and Vesting Schedules
- SAFE vs Convertible Note
- Corporate Transparency Act / BOI Reporting (2026 Status)
- Who Owns Your Startup's IP (and How to Make Sure It's the Company)
- Can I Advertise My Raise? Rule 506(b) vs 506(c)
- What Is a 409A Valuation and When Does My Startup Need One?
- Does Registering My LLC Protect My Brand Name? (Startup Trademarks)