Whether a worker is a W-2 employee or a 1099 independent contractor determines whether you owe unemployment insurance tax, must submit new hire reports, and carry workers' comp obligations. Texas uses a "direction and control" test that largely mirrors IRS rules — and getting it wrong can cost your LLC back taxes, penalties, and interest.

Quick reference

Step 1 — Apply the Texas TWC direction and control test

The Texas Workforce Commission determines worker status using a direction and control test. The more control you exercise over how work is performed, the more likely the worker is an employee.

TWC looks at factors including:

• Behavioral control — Do you control how the worker performs the work (not just what the outcome is)?
• Financial control — Does the worker invest in their own tools, set their own rates, and work for multiple clients?
• Type of relationship — Is there a written contract? Benefits? Is this work integral to your core business?

Common mistake: Having a "1099 contract" does not make someone a contractor. The IRS and TWC look at actual working conditions, not the label on the paperwork.

Step 2 — Apply the IRS 3-category test

For federal tax purposes, the IRS uses three categories to evaluate classification:

Behavioral Control

• Do you control what the worker does and how they do it?
• Do you provide training or set work schedules?

Financial Control

• Does the worker have a significant investment in their tools or equipment?
• Can they profit or lose money from the work?
• Do they make services available to the general market?

Type of Relationship

• Is there a written contract?
• Does the worker receive benefits (health insurance, vacation, retirement)?
• Is the relationship permanent or project-based?
• Is the work integral to your business's regular operations?

No single factor is decisive — the IRS looks at the full picture. If you're unsure, you can file IRS Form SS-8 to request an official determination.

Step 3 — W-2 employee obligations in Texas

If a worker is a W-2 employee, your LLC owes:

Step 4 — 1099 independent contractor obligations

If a worker is a legitimate independent contractor, your LLC owes:

The contractor is responsible for their own taxes, insurance, and business expenses.

Step 5 — What happens if you misclassify a worker?

TWC and the IRS audit classification regularly. If they determine your "contractor" was actually an employee:

• TWC will assess back UI taxes, penalties, and interest for all quarters affected
• IRS may assess back FICA taxes, income tax withholding, and federal unemployment (FUTA) taxes
• You may also face civil liability if the misclassified employee was injured and you lacked workers' comp

The IRS has a Voluntary Classification Settlement Program (VCSP) that lets you proactively reclassify workers with reduced penalties — worth exploring if you suspect misclassification.

FAQ

What is the main difference between a W-2 employee and a 1099 contractor in Texas?

An employee works under your direction and control — you set their schedule, provide tools, and integrate them into your business operations. A contractor operates independently, works for multiple clients, uses their own tools, and bears financial risk on the job. The label on a contract doesn't control the classification.

Does Texas have its own worker classification rules separate from the IRS?

Yes. The Texas Workforce Commission applies a "direction and control" test to determine whether UI tax is owed. This test is similar to — but separate from — the IRS test. Being classified as a contractor for IRS purposes doesn't guarantee the same result at TWC.

What is the penalty for misclassifying an employee as a contractor in Texas?

TWC can assess back unemployment insurance taxes, interest, and penalties for all affected quarters. The IRS can assess unpaid FICA, income tax withholding, and FUTA taxes. Penalties can be significant, especially for multi-year misclassification.

Can I ask the IRS to make a worker classification determination?

Yes. File IRS Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes) and the IRS will review the facts and issue a determination. This is slow (can take several months) but provides legal certainty.

If I use contractors exclusively, do I still owe UI tax in Texas?

No. UI tax is only owed on wages paid to W-2 employees. If all your workers are legitimate independent contractors, you have no UI tax obligation. However, if TWC determines any contractor is actually an employee, you'll owe back taxes on their compensation.

Not sure what else your Texas LLC owes?

Most business owners are surprised by how many filing obligations they have. Ortholo's free compliance checker shows you everything you owe, when it's due, and what happens if you miss it — personalized to your entity.

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Last verified: 2026-06-08

Sources: Texas Workforce Commission — Tax Information, IRS — Independent Contractor vs. Employee

Related guides: Texas unemployment insurance tax filing · Texas employer requirements when you hire your first employee