What Contractors Need to Know About 1099 vs W-2 Workers

The IRS Is Watching

Worker misclassification is the #1 tax enforcement issue for contractors. The IRS, DOL, and state agencies are actively auditing contractors who treat employees as 1099 subs to avoid payroll taxes.

The Key Test: Control

The IRS uses a "right to control" test:

W-2 Employee if you control:

• When and where they work
• What tools they use (you provide them)
• How the work is performed
• They work exclusively/primarily for you
• You provide training

1099 Subcontractor if they control:

• Their own schedule
• Their own tools and equipment
• How the work is done (you specify what, not how)
• They have other clients
• They have their own business license/insurance

The Cost of Getting It Wrong

If the IRS reclassifies your 1099s as W-2s:

• Back payroll taxes: 7.65% of all wages (FICA)
• Penalties: 20-40% of unpaid employment taxes
• Back workers' comp premiums
• State unemployment insurance
• Potential lawsuits from workers for benefits

On a sub you paid $50,000: reclassification could cost you $15,000-25,000 in back taxes and penalties.

Safe Harbor

To safely use 1099 subs:

1. They have their own business entity (LLC, corp)
2. They carry their own insurance
3. They have other clients
4. They submit invoices (not timesheets)
5. You have a written subcontractor agreement
6. They use their own tools

Your next step: Review every person you pay as 1099. Do they pass the control test? If not, consult a CPA before the IRS finds you first.