The basic difference comes down to control. A W-2 employee works under your direction. You tell them when to show up, how to do the work, and you provide the tools and equipment. A 1099 contractor is running their own business. They control how the work gets done, they use their own tools, and they typically work for multiple clients.

From a tax standpoint, the difference is significant. For W-2 employees, you withhold federal and state income tax, Social Security, and Medicare from their pay. You also pay the employer portion of Social Security and Medicare, plus California unemployment insurance and employment training tax. For a 1099 contractor, you pay them the agreed amount and that’s it. No withholding, no employer taxes. They’re responsible for their own self-employment taxes and quarterly estimated payments.

At year end, you issue a W-2 to employees and a 1099-NEC to independent contractors you paid $600 or more during the year.

This is where it gets important for construction and trades businesses. The industry has a long history of treating workers as 1099 contractors when they’re really functioning as employees. Sometimes it’s intentional to save on payroll taxes and workers’ comp. Sometimes business owners genuinely don’t know the rules. Either way, the consequences are the same.

California uses the ABC test under AB5, which is stricter than the federal standard. To classify someone as an independent contractor in California, all three conditions must be met. The worker is free from your control and direction. The work they perform is outside the usual course of your business. And the worker has an independently established trade or business of the same type. That second condition trips up a lot of contractors. If you’re a general contractor and you hire framers who only work your jobs, show up when you tell them to, and don’t have their own contractor’s license or other clients, California will likely consider them employees regardless of what your agreement says.

The penalties for misclassification add up fast. You can owe back payroll taxes plus penalties and interest, sometimes going back several years. California’s Employment Development Department actively audits construction businesses for this. The IRS can assess additional taxes on top of what the state collects. And if a worker gets hurt on the job and they were misclassified, your liability exposure is serious.

The right approach is to classify workers correctly from the start and set up your payroll and bookkeeping to reflect reality. If someone is an employee, put them on payroll. If you’re working with a legitimate subcontractor who has their own license, insurance, and other clients, a 1099 arrangement makes sense.

If you’re unsure about your current setup, it’s worth getting it reviewed. Fixing misclassification before an audit is far less expensive than fixing it during one. Our bookkeeping and tax services for contractors include making sure your worker classifications are handled correctly in the books so nothing falls through the cracks at tax time or during an EDD inquiry.