Startup Founders – Do NOT pay yourself as a 1099 Contractor
Startup founders should not pay themselves as 1099 contractors; instead, they should be W-2 employees due to compliance, tax, and long-term business benefits.
Legal Compliance Risks
Classifying founders as 1099 contractors is often not legally defensible. Founders regularly control business operations, work full-time, and act as integral parts of the company, fitting the IRS definition of an employee rather than an independent contractor. Misclassifying staff can result in costly penalties, back taxes, and mandatory payment of unpaid benefits if the IRS or state agencies audit and determine the founders were incorrectly treated as contractors.
Tax and Financial Implications
W-2 employees only pay half of their payroll (FICA) taxes, while 1099 contractors pay the full 15.3% self-employment tax on their earned income. Startups that misclassify founders force them to shoulder this entire tax burden. Furthermore, paying as a contractor denies access to pre-tax benefits such as company-sponsored health insurance and retirement plans, which can increase out-of-pocket living expenses and make the startup less attractive for future equity-backed compensation.
Administrative and Business Drawbacks
Treating founders as contractors complicates accounting and payroll, especially if the founders are later “converted” to W-2 employees for fundraising or compliance reasons. This dual classification raises audit red flags and can create extra onboarding work for internal teams, wasting time and resources. In the eyes of investors and future employees, a clean, compliant W-2 structure signals operational maturity and readiness to scale.
Recruiting and Retention
Founders and top talent typically seek basic legal protections and benefits offered only to employees (minimum wage guarantees, overtime eligibility, access to group health coverage, statutory leaves, etc.). Avoiding a W-2 structure makes it harder to hire and retain key staff—particularly as the business transitions from early seed stages to more formalized operations.
Conclusion
To protect against regulatory risk, optimize tax treatment, simplify business operations, and remain competitive in attracting talent, startup founders should consistently treat themselves as W-2 employees, not 1099 contractors.