Small Business Hiring Explained in a Nutshell

An owner decides to bring someone on. It seems like a simple question: what is this person to the business?

Then the vocabulary arrives. Employee. Contractor. W-2. 1099. Full-time. Part-time. Temporary. Seasonal. Hourly. Salaried. Exempt. Nonexempt.

Most of the confusion comes from treating these words as different answers to the same question. They are not. They are answers to four different questions, and one person can carry several labels at once. A front-desk worker might be an employee who is part-time, paid hourly and nonexempt from overtime. A store manager might be an employee who is full-time, salaried and exempt. The web designer who rebuilt the site might not be an employee at all.

This paper sets out what federal agencies say about each classification, a four-layer map that puts the labels in order, worked examples, and a short test for deciding them in the right sequence.

What do the rules and the data say?

Worker classification is governed mostly by federal agencies and state law rather than by academic research, so this paper relies on primary government sources: the Internal Revenue Service, the U.S. Department of Labor and the Bureau of Labor Statistics.

The relationship decides, not the label

For federal employment taxes, the IRS uses the common-law rules and looks at all evidence of the degree of control and independence in the relationship. It groups that evidence into three categories: behavioral control, financial control and the relationship of the parties. ^[1] The deciding question is control: "What matters is that the business has the right to control the details of how the worker's services are performed." ^[2]

The consequences of getting it wrong fall on the business. In the IRS's words, "If a business misclassified an employee, the business can be held liable for employment taxes for that worker." ^[2]

Two agencies, two tests

The IRS and the Department of Labor do not use identical tests. The IRS applies its common-law control test for tax purposes. ^[1] The Department of Labor decides worker status under the Fair Labor Standards Act, the federal minimum-wage and overtime law, using an "economic reality" analysis of whether a worker is economically dependent on the business or in business for themselves.

That federal labor test is changing in 2026. On February 26, 2026, the Department of Labor proposed replacing its 2024 independent-contractor rule, which it says it is no longer applying in its investigations. The proposal centers on two core factors: the worker's control over the work, and the worker's opportunity for profit or loss based on initiative or investment. The comment period closed April 28, 2026; as of this paper's publication, no final rule has been announced on the Department's rulemaking page. ^[3] Many states apply their own tests as well, and some are stricter than either federal test.

"Full-time" has no single federal definition

The Fair Labor Standards Act "does not define full-time employment or part-time employment. This is a matter generally to be determined by the employer." Being full-time or part-time "does not change the application of the FLSA." ^[4] Other laws do set their own lines. For the Affordable Care Act's employer rules, for example, the IRS treats an employee averaging at least 30 hours of service a week, or 130 hours in a month, as full-time. ^[5] An owner's internal definition and a law's definition can differ, and the law's definition controls for that law.

Contractors are common, and so is confusion

In July 2023, the Bureau of Labor Statistics counted 11.9 million independent contractors, 7.4% of total U.S. employment, plus 945,000 workers placed by temporary help agencies. ^[6] Contracting is a normal, legitimate way to work. The problem is not contractors; it is calling an employee a contractor.

The overtime salary line in 2026

To be exempt from overtime under the main federal "white-collar" exemptions, an employee generally must be paid on a salary basis, at least $684 per week, and perform duties that meet the regulations' tests. The Department of Labor states plainly: "Job titles do not determine exempt status." ^[7] The $684 level returned after a federal court vacated the Department's 2024 increase in November 2024; the Department published a technical amendment restoring the 2019 levels on May 15, 2026. ^[8] Several states set higher thresholds.

Groundwork's assessment: The labels are not choices an owner makes for convenience. They are conclusions that follow from how the work is actually set up.

The Groundwork Classification Map

Every classification question fits into one of four layers. Answer them in order.

The layers stack. A seasonal worker is still an employee. A salaried worker can still be owed overtime. And a contractor sits outside layers 2 to 4 entirely, because those layers describe employment.

Layer 1: Employee or independent contractor?

Employee

An employee works within the business under an employment relationship. The IRS looks at whether the business has the right to control the work, even if it rarely exercises that right. ^[1] A skilled employee who needs little supervision is still an employee if the business could direct how the work is done.

Independent contractor

A genuine independent contractor is running their own business. They decide how the work gets done, invest in their own tools, can make or lose money on the job, and usually serve other customers too. The IRS weighs this evidence under its three categories:

No single factor settles it, and a signed "independent contractor agreement" does not override how the work actually runs. ^[1]

A practical way to spot the difference: an employee works for your business; a contractor is another business working for yours. Compare a bookkeeping firm that serves many clients and invoices you monthly with a person who sits at your front desk every weekday on a schedule you set, trained in your procedures. Calling the second person a contractor does not make them one.

"But they want to be paid on a 1099"

This is the most common small-business mistake. W-2 and 1099 are tax forms that report a relationship; they are not options an owner or worker can pick. When a business is unsure, the IRS offers two routes: Form SS-8 asks the IRS to determine a worker's status, ^[1] and the Voluntary Classification Settlement Program lets an eligible business reclassify workers as employees going forward with partial relief from federal employment taxes. ^[2]

Layer 2: How will the employee work?

Full-time. An employee on the business's full schedule. Federal wage law leaves the definition to the employer, ^[4] but some laws, such as the Affordable Care Act's employer rules, use their own hour lines. ^[5]

Part-time. Fewer scheduled hours. Part-time describes the schedule, not independence: a receptionist working 18 hours every week is a part-time employee, not a contractor. Part-time and seasonal employees are subject to the same federal income tax withholding, Social Security and Medicare rules as other employees. ^[9]

Seasonal. An employee who works during a recurring busy period: holiday retail, summer recreation, harvest, tax season. Seasonal does not mean contractor. The IRS does ease one filing burden: a seasonal employer generally does not have to file Form 941 for quarters in which it paid no wages, provided it checks the seasonal-employer box on the returns it does file. ^[9]

Temporary. Describes duration: eight weeks of cover during a leave, or a short production push. A temporary employee is still an employee. A worker placed by a staffing agency is usually on the agency's payroll, though responsibility for the worker can be shared, so read the agency agreement.

Layer 3: How is the employee paid?

Hourly. Pay is calculated from hours worked. It makes labor cost easy to see and track.

Salaried. A set amount per pay period regardless of the exact hours. Paying a salary is a pay method, not an overtime decision. Which brings us to the most expensive misunderstanding in this paper.

Layer 4: Is the employee owed overtime?

Nonexempt. Protected by the federal minimum-wage and overtime rules: time and one-half the regular rate for all hours worked over 40 in a workweek. ^[7] Most hourly employees are nonexempt, and a salaried employee can be nonexempt too.

Exempt. Falls within a specific exemption. For the common white-collar exemptions, three tests must all be met: paid on a salary basis, at least $684 a week, and actual duties that meet the regulations. ^{[7] [8]} Titles like "manager," "director" or "coordinator" do not decide it; the real job does. ^[7]

Two more you will meet

Interns. At a for-profit business, whether an intern must be paid depends on who primarily benefits from the arrangement. The Department of Labor describes a seven-factor "primary beneficiary test," and an intern who is really an employee is owed minimum wage and overtime. ^[10]

Family members. Relatives can be employees like anyone else, and some family employment has special federal tax treatment. ^[11] See our paper Should You Hire a Family Member? for the management side.

Example: five workers, one map

This is a hypothetical example to show the map at work. The people and figures are illustrations.

The last row does not need forcing into employee categories. That is the point of doing layer 1 first.

The Groundwork Owner's Test

Before asking "W-2 or 1099?", work down the layers:

1. Relationship. Is this employment, or an independent business serving yours?
2. Arrangement. If an employee: full-time, part-time, seasonal or temporary?
3. Pay. Hourly or salary?
4. Overtime. Nonexempt, or does a specific exemption truly apply?
5. Paperwork. Only now choose the forms, payroll setup and records that match the answers.

Our paper When Should a Small Business Hire Its First Employee? covers the cost side once the classification is settled.

Common classification mistakes

• Choosing 1099 to save on payroll. The relationship decides, not the form or the worker's preference. ^{[1] [2]}
• Treating part-time as contract work. Part-time is a schedule. ^[9]
• Assuming salary means no overtime. Salary is a pay method; exemption requires the salary level and the duties test. ^[7]
• Promoting by title. A "manager" title does not create an exemption. ^[7]
• Relying on an old checklist. The federal labor test is under active rulemaking in 2026, and states have their own rules. ^[3]
• Unpaid "internships" that are really jobs. The primary beneficiary test applies at for-profit businesses. ^[10]

When the answer is not clear

Sometimes it genuinely is not. Form SS-8 can get an IRS determination for federal tax purposes. ^[1] State law can add requirements, and where federal and state wage rules both apply, employees generally get the more protective one. Groundwork is not a law firm, and this paper is not legal or tax advice: when a classification is borderline, a payroll provider, CPA or employment attorney in your state is worth far more before the first paycheck than after an audit.

Frequently asked questions

What is the difference between an employee and an independent contractor?

An employee works within your business, and you have the right to control how the work is done. An independent contractor runs their own business: they control how the work is done, invest in their own tools, can make or lose money and typically serve other customers. The IRS weighs behavioral control, financial control and the relationship of the parties.

Can I pay a worker on a 1099 if they ask me to?

Not if the relationship is really employment. W-2 and 1099 report a relationship; they do not create one. A business that misclassifies an employee can be held liable for employment taxes.

How many hours is full-time?

Federal wage law does not define it; the employer generally decides. Some laws set their own lines, such as an average of 30 hours a week for the Affordable Care Act's employer rules.

Are salaried employees exempt from overtime?

Not automatically. For the common white-collar exemptions, the employee must be paid on a salary basis, at least $684 a week under the federal rule in 2026, and perform duties that meet the exemption's tests. Some states set higher thresholds.

Do part-time and seasonal employees need payroll taxes withheld?

Yes. The IRS applies the same federal income tax withholding, Social Security and Medicare rules to part-time and seasonal employees as to other employees.

Groundwork's final assessment

The vocabulary sounds complicated because four different questions get discussed at once. Separate them and the picture clears: employee or contractor is the relationship; full-time, part-time, seasonal or temporary is the arrangement; hourly or salary is the pay method; exempt or nonexempt is overtime treatment.

An owner does not need to become an employment lawyer to use that map. But the owner does need to recognize the moment a classification decision moves from routine administration into territory where qualified payroll, tax or legal guidance should come first.

Put Groundwork to work for your business

Planning a hire? Groundwork writes clear job descriptions that define the role, schedule and pay before you post it, and our Second Pair of Eyes service gives an independent review of a hiring decision before you commit. Every Groundwork project is fixed-price. Groundwork is not a law firm and does not provide legal or tax advice.