The difference between an employee and a subcontractor comes down to who controls the work and who carries the risk. An employee works under the hiring company’s direction, gets taxes withheld from each paycheck, and is covered by federal wage and anti-discrimination laws. A subcontractor runs their own operation, invoices for completed work, pays both halves of Social Security and Medicare out of pocket, and goes without the labor protections employees take for granted. The label on a contract doesn’t settle it. The IRS and the Department of Labor both look past paperwork to how the arrangement actually works.
What Actually Separates the Two
The IRS sorts the question into three areas: behavioral control, financial control, and the type of relationship between the parties. No single factor decides it. The agency looks at the full picture.1Internal Revenue Service. Independent Contractor (Self-Employed) or Employee?
Behavioral control is about direction. Employees get told when to start, which tools to use, where to buy supplies, and who to bring on as help. Training a worker in the company’s specific methods is especially strong evidence of employment, because it shows the business wants the job done its way.2Internal Revenue Service. Behavioral Control Subcontractors use their own methods to reach an agreed-upon result. The hiring party focuses on the finished product, not the day-to-day details.
Financial control looks at who bears the economic risk. Subcontractors often make real investments in their own equipment, software, or workspace, and they carry unreimbursed expenses like marketing or licensing. They can actually lose money on a job. Employees collect a regular wage regardless of how a given week turns out, and the employer absorbs the costs of doing business.3Internal Revenue Service. Financial Control
The type of relationship covers how the parties treat each other. Offering health insurance, a pension, vacation pay, or a 401(k) looks like employment. An open-ended arrangement with no end date looks like employment. A contract for a specific deliverable with a completion date looks like a contractor engagement. And when the work is a core part of what the company does rather than a one-off specialty, the IRS leans toward employee status.
One more wrinkle worth flagging. The Department of Labor applies its own test under the Fair Labor Standards Act, and that framework is in flux: a 2024 rule used a six-factor totality analysis, and a 2026 proposed rule would replace it with a streamlined five-factor test giving extra weight to control and to opportunity for profit or loss.4U.S. Department of Labor. Notice of Proposed Rule: Employee or Independent Contractor Classification The IRS test governs taxes; the DOL test governs wage-and-hour protections. A worker can be an employee under one and a contractor under the other, though in practice the analyses usually line up.
Who Pays What in Taxes
This is where the two paths split hardest. For an employee, the employer withholds federal income tax plus the employee’s share of Social Security and Medicare (FICA) from every paycheck. The employer then matches the FICA contributions and sends both halves in: 6.2% for Social Security on wages up to $184,500 in 2026, and 1.45% for Medicare on all wages.5Social Security Administration. Contribution and Benefit Base At year-end, the employee gets a Form W-2 showing total earnings and taxes withheld.6Internal Revenue Service. About Form W-2, Wage and Tax Statement
For a subcontractor, the hiring business generally withholds nothing. Starting in 2026, the Form 1099-NEC reporting threshold rose from $600 to $2,000, so a company must issue a 1099-NEC only when it pays a contractor $2,000 or more during the calendar year.7Internal Revenue Service. Form 1099 NEC and Independent Contractors The contractor handles all of their own taxes.
Including both halves of FICA. Employees split those contributions with the employer; a self-employed contractor pays both sides, for a combined self-employment tax rate of 15.3% on net earnings.8Internal Revenue Service. Self-Employment Tax (Social Security and Medicare Taxes) The Social Security portion applies to net earnings up to the same $184,500 base in 2026; the Medicare portion has no cap.5Social Security Administration. Contribution and Benefit Base That extra 7.65% is effectively a pay cut compared with what an employee earning the same gross amount takes home. Self-employed workers can deduct the employer-equivalent half when calculating adjusted gross income, which softens the hit without erasing it. First-time freelancers get caught by this often enough that it belongs at the top of any contractor’s budgeting.
Protections an Employee Gets That a Subcontractor Doesn’t
Classification determines access to a whole catalog of federal and state protections. The Fair Labor Standards Act guarantees employees a minimum wage of $7.25 per hour and overtime pay at one-and-a-half times the regular rate for hours beyond 40 in a workweek.9U.S. Department of Labor. Wages and the Fair Labor Standards Act Employees who lose a job through no fault of their own can draw unemployment insurance, funded by employer contributions through federal unemployment tax (currently 0.6% on the first $7,000 of each employee’s wages after credits) plus state unemployment taxes.10U.S. Department of Labor. FUTA Credit Reductions Workers’ compensation, required in nearly every state, pays medical bills and lost wages for on-the-job injuries.
Federal anti-discrimination law also runs along the same line. Title VII of the Civil Rights Act, the Americans with Disabilities Act, and the Age Discrimination in Employment Act protect employees. A worker classified as a contractor generally cannot bring a federal discrimination claim against the hiring company, even when the day-to-day relationship resembles employment.
Subcontractors carry those risks themselves. No minimum wage, no overtime, no unemployment benefits, no workers’ comp. They need to arrange their own liability insurance and disability coverage. The theoretical trade-off is genuine independence: the freedom to set rates, pick clients, and build a book of business. When a company keeps the control of an employment relationship but keeps the contractor label to avoid the costs, that’s misclassification.
What Happens When the Label Is Wrong
The exposure runs in both directions, but it falls heavier on the business. When the IRS reclassifies a contractor as an employee, the company owes back employment taxes. Section 3509 of the Internal Revenue Code sets reduced rates if the employer at least filed the required 1099 forms: 1.5% of wages for income tax withholding and 20% of what the employee’s FICA share would have been.11Office of the Law Revision Counsel. 26 USC 3509 – Determination of Employer’s Liability for Certain Employment Taxes Those rates double when the employer skipped the 1099s, and the reduced rates disappear altogether if the IRS finds the misclassification was intentional. At that point the employer owes the full amount that should have been withheld and paid, plus interest and potential fraud penalties.
The IRS isn’t the only forum. Misclassified workers can sue under the FLSA for unpaid overtime and minimum wage. The Department of Labor can pursue its own enforcement. State unemployment agencies and workers’ compensation boards may come in with separate assessments for skipped contributions.
A worker who thinks they’ve been wrongly labeled a contractor has a direct path. Either the worker or the hiring firm can file Form SS-8 with the IRS, which asks for a formal determination of employment status for federal tax purposes.12Internal Revenue Service. About Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding While that review is pending, the worker can file Form 8919 with their tax return and pay only the employee’s share of Social Security and Medicare on the disputed wages instead of the full 15.3% self-employment tax.13Internal Revenue Service. About Form 8919, Uncollected Social Security and Medicare Tax on Wages Filing Form 8919 puts the IRS on notice and keeps the worker from overpaying while the question gets sorted out.