Contractors vs. Employees: What Most Companies Get Wrong (and How to Fix It)
One of the biggest legal mistakes I see growing companies make — especially startups and creative businesses — is misclassifying workers as independent contractors (1099) instead of employees (W-2).
It’s rarely intentional. Usually, founders are just trying to stay lean, flexible, or move quickly. But misclassification isn’t a small technicality — it can lead to serious tax liabilities, back pay, penalties, and even personal exposure for founders.
The good news? It’s fixable — and with the right systems in place, you can stay compliant and keep your business agile.
The Core Difference: Control and Independence
The difference between contractors and employees comes down to control — who directs the work, how it’s done, and where it’s performed.
A 1099 contractor is self-employed. They control their own hours, tools, and process. You can define the deliverable, but not how they get there.
A W-2 employee works for your business. You set their schedule, oversee their work, and provide the resources to do it.
If you’re managing someone day-to-day, setting expectations, or integrating them into your team — they’re probably an employee, no matter what the contract says.
The Legal and Financial Risks
When you misclassify, you don’t just risk an IRS audit — you can trigger:
Payroll tax penalties and unpaid employment taxes
Wage and hour violations (especially unpaid overtime)
Workers’ comp and unemployment compliance issues
State law penalties that can exceed the federal ones
The IRS, Department of Labor, and state agencies all have different tests for classification, and most lean toward “employee” when in doubt.
For small businesses and startups, that means a single misclassification can snowball fast — especially if multiple contractors are later deemed employees.
The Practical Reality: Everyone’s Blurring the Lines
In today’s creative and digital economy, the contractor/employee line is often blurred. People work remotely, part-time, and across multiple projects. Founders assume that labeling someone a “freelancer” in a contract is enough.
It’s not. The law looks at how the relationship functions — not what you call it.
Even if your team works flexibly, you can structure things safely with the right documentation and support systems in place.
How to Fix It — and Protect Your Business
If you’ve been using contractors, the solution isn’t panic — it’s planning.
Audit your relationships. Identify who’s truly independent and who functions like an employee.
Reclassify where needed. If someone’s working full-time hours and reporting to your team, it’s usually safer to make them a W-2 employee.
Use a PEO (Professional Employer Organization).
A PEO like Justworks — one of our trusted HR partners — helps companies manage payroll, HR, compliance, and benefits under one roof. They make it simple to onboard employees correctly, pay taxes accurately, and stay compliant across all 50 states.
We’ve worked with Justworks across multiple client matters and highly value their platform for making compliance simple for founders and small teams.
If you’re scaling your company or transitioning contractors into employees, we can connect you with Justworks directly to ensure a smooth, compliant transition.
At WADR Law
We help startups, creative businesses, and founders set up the right structures for growth — from compliant hiring practices to scalable HR systems. Whether you’re correcting misclassifications or building a compliant team from day one, our team can guide you through both the legal and operational steps.
When you’re ready to formalize your team, we’ll make sure you’re set up with the right systems — including trusted partners like Justworks — to handle compliance, payroll, and benefits the right way.
Disclaimers
Nothing in this article or any related communication constitutes legal advice or creates an attorney-client relationship. Every business situation is unique, and you should consult your own counsel for advice specific to your company.
WADR Law does not receive any referral fees, commissions, or financial benefit from Justworks. We recommend them purely based on their reliability and value in helping clients maintain HR and payroll compliance.