Is my business required to have a formal payroll, or can I just provide 1099s to people who work for me?  

Whether to pay someone as an employee (W2) or contractor (1099NEC) is dependent on how they are classified based on general areas of independence and degree of control. Below are a few things that fall under these areas. 

It is appropriate to issue 1099s if:

• You have contracts for the work.

• The contract employee controls how, when, and where they work.

• They use their own tools, set their own schedule, and may work for others.

• There are no employee benefits (e.g., health insurance, retirement plans).

• You do not withhold taxes from their pay, unless required by a taxing agency.

In this case, you issue a Form 1099-NEC for each contractor you paid $600 or more during the year.

You would run a payroll (paying an employee and issuing a W2) if:

• You have employees (even just one).

• You control how the work is done, when it’s done, and provide the tools.

• You offer benefits or require the person to work specific hours.

• You are an owner compensating yourself as an employee from an S-Corporation.

This means setting up withholdings for income tax, Social Security, Medicare, unemployment taxes (FUTA/SUTA), and issuing W-2s.

Key points to remember:

The IRS is strict about misclassifying employees as contractors. Penalties can be steep if you're audited and there could be back taxes to pay.

If you’re an LLC taxed as an S-Corp, and you’re working in the business, the IRS requires you to pay yourself a “reasonable salary” through payroll.



If you’re unsure about how to classify an employee or contractor, the IRS has a form (SS-8) you can submit to request a determination. Or CB Smith can help you make the appropriate decision.  We are always here to help our clients with these business situations. 

Mary Smith, SHRM-SCP