W-2 Employee vs. 1099 Contractor: A North Carolina Employer’s Guide

Understanding the Basic Distinction

As a business owner, one of the most important decisions you’ll make is how to classify your workers. The distinction between a W-2 employee and a 1099 independent contractor isn’t just about paperwork—it fundamentally affects your tax obligations, liability exposure, and legal compliance.

W-2 employees work under your supervision and control. You direct how, when, and where they perform their work. You withhold income taxes, pay Social Security and Medicare taxes, provide workers’ compensation coverage, and may offer benefits.

1099 independent contractors are self-employed individuals who provide services to your business but maintain control over how they complete the work. You simply pay them for results, and they handle their own taxes, insurance, and business expenses.

The problem? Many businesses assume they can simply choose which classification is more convenient or cost-effective. That’s not how the law works.

The Legal Framework: North Carolina’s Eight-Factor Test

North Carolina courts don’t rely on what you call someone or what your contract says. Instead, they look at the actual working relationship. The North Carolina Supreme Court in Hayes v. Board of Trustees established an eight-factor test that examines the worker’s level of independence:

1. Independent business or occupation: Does the worker operate their own established business with multiple clients, or do they work primarily for you?
2. Special skills and expertise: Does the worker apply specialized knowledge or training independently, or are they following your methods and procedures?
3. Fixed price or quantitative basis: Is the worker paid for completing a specific project or deliverable, or are they paid by the hour or receive a regular salary?
4. Freedom in work methods: Can the worker choose their own approach to completing the work without fear of termination, or must they follow your prescribed methods?
5. Not in regular employ: Is this a one-time or project-based engagement, or does the worker provide ongoing, regular services?
6. Freedom to use assistants: Can the worker hire helpers or subcontractors as they see fit, or must they perform the work personally?
7. Control over assistants: If assistants are used, does the worker supervise and pay them, or do you?
8. Control over timing: Does the worker set their own schedule and decide when to work, or do you set their hours?

No single factor is decisive. Courts examine the totality of circumstances to determine whether the worker possesses genuine independence.

The Right to Control Test: The Critical Question

Beyond the eight factors, North Carolina law emphasizes the “right to control” test. This is perhaps the most important consideration: Do you retain the right to control and direct the manner and method of the work performed?

Notice the emphasis on “right to control”—even if you don’t actively micromanage someone, if you could control how they do their work, that suggests an employment relationship.

For example, if you could legally tell a worker to use a specific software program, follow certain procedures, or work specific hours—even if you rarely exercise that control—courts may find an employment relationship exists.

When It’s Appropriate to Use 1099 Contractors

Independent contractors are appropriate when you need:

• Specialized expertise for a specific project (e.g., redesigning your website, conducting a financial audit, or creating marketing materials)
• Temporary or seasonal help for discrete tasks with a defined beginning and end
• Services from established businesses that serve multiple clients and operate independently

A true independent contractor operates their own business, sets their own prices, markets their services to multiple clients, provides their own tools and equipment, and can profit or lose based on their business decisions.

When You Must Use W-2 Employees

You should classify workers as employees when:

• They perform core business functions on an ongoing basis
• You need to control how and when work is performed
• You provide training on your methods and procedures
• Workers use your equipment and workspace
• The relationship is indefinite or long-term
• You need them to work specific hours or schedules

If someone sounds like an employee when you describe what they do, they probably are one—regardless of what you’d prefer for budget reasons.

The Consequences of Misclassification

Getting worker classification wrong isn’t a minor paperwork issue. It can expose your business to significant risks:

Tax Penalties and Back Payments

If you misclassify employees as contractors, you may owe:

• Back payroll taxes (Social Security, Medicare, and unemployment taxes)
• Penalties and interest on unpaid taxes
• The employer’s share of taxes you should have withheld

The IRS and North Carolina Department of Revenue actively investigate misclassification, and they can look back several years.

Legal Liability

Misclassified workers may be entitled to:

• Overtime pay under the Fair Labor Standards Act and North Carolina Wage and Hour Act
• Workers’ compensation benefits if injured
• Unemployment benefits
• Employee benefits you provided to others

The North Carolina Wage and Hour Act may define “employee” more broadly than common law tests, potentially expanding your exposure.

Loss of Independent Contractor Defense

If you classify someone as a contractor, you typically aren’t liable for their negligent actions. But if a court determines they were actually an employee, you could face liability for injuries or damages they cause.

Reputational and Operational Damage

Beyond legal consequences, misclassification disputes damage relationships with workers, create negative publicity, and distract from running your business.

Practical Guidance for Employers

Here’s how to protect your business:

Document the relationship carefully: Use written agreements that reflect the actual working arrangement, but remember—the reality of the relationship matters more than what the contract says.

Conduct periodic audits: Review your worker classifications regularly, especially for long-term “contractors” whose roles may have evolved into employee-like positions.

When in doubt, classify as an employee: The costs of misclassification far exceed the additional payroll taxes and administrative work of proper classification.

Consult legal and tax professionals: Worker classification is complex and fact-specific. Professional guidance can prevent costly mistakes.

Consider the economic realities: Courts increasingly look at factors like economic dependence, permanence of the relationship, and the worker’s opportunity for profit or loss. If someone depends on you for their livelihood, they’re likely an employee.

Conclusion

Worker classification isn’t about finding loopholes or saving money—it’s about accurately reflecting the nature of your working relationships. North Carolina law provides clear guidance through the eight-factor test and right to control analysis. By understanding these principles and applying them honestly, you can build a compliant workforce that protects both your business and your workers.

When you’re making classification decisions, ask yourself: Does this person really operate independently, or are they integrated into my business operations? The answer to that question should guide your classification choice.

Revolution Law Group is located in Greensboro, NC, and serves individuals and small businesses throughout the Triad and surrounding areas. To contact us please visit Revolution.law or call 336-333-7907.

The information included here is for informational purposes only, is not exhaustive of all considerations when creating documents, is not intended to be legal advice, and should not be relied upon for that purpose. We strongly recommend you consult with an attorney and do not attempt to create your own documents.