1099 or Employee? The IRS Test Explained Simply

You open the mailbox and find a letter from the state.

They’re reclassifying your three “subcontractors” as employees. You now owe $47,000 in back payroll taxes, penalties, and workers’ comp premiums — plus interest. And they can audit multiple years.

This happens constantly in construction. A GC we worked with misclassified two laborers as 1099s. The state hit him with a $27,000 bill after a random audit. He didn’t even do anything unusual.

A lot of contractors fall into this trap for the same reasons: You need labor fast. You don’t want to deal with payroll. Workers’ comp is expensive. And half the people who show up to your jobsite ask to be paid as 1099s because they “don’t want taxes taken out.”

On top of that, every contractor knows another contractor who “pays everyone as a sub and it’s fine.”
So it feels normal.
It feels easier.
It feels like the smarter way to run your business.

The problem is: the IRS, your workers’ comp carrier, and your state labor department don’t care about what’s easier. They care about the actual working relationship, not what the paperwork says.

This article breaks down how the IRS really thinks about classification, with real construction examples you’ll recognize.

1. The Three Big Things the IRS Actually Cares About

Forget the old 20-point test. The IRS looks at three main pillars when deciding whether someone is an employee or subcontractor. No single factor decides the case — they look at the whole picture.

1. Behavioral Control

Who tells them how to do the work?

Employee signals:

• You set their hours, sequence, and process

• You train them on your methods

• You supervise them daily

Contractor signals:

• They decide how and when work gets done

• They use their own methods

• They work without day-to-day supervision

2. Financial Control - Who carries business risk?

Employee signals:

• You provide tools, truck, materials, PPE

• They’re paid hourly or weekly

• You reimburse their expenses

Contractor signals:

• They bring their own tools/equipment

• They quote flat rates or bid jobs

• They can make a profit or take a loss (if the job goes fast, they make more; if it runs long, they eat the cost)

3. Relationship of the Parties - How is the relationship structured?

Employee signals:

• Ongoing, open-ended work

• They only work for you

• Their work is your core business

Contractor signals:

• Project-based with a defined end

• They work for multiple clients

• They have a business entity

Key point:

A signed 1099 agreement does nothing if everything else looks like an employee relationship.

2. Real Construction Examples - Who Counts as What

Here’s what these rules look like on real jobsites.

Clearly an Employee

Framing crew member who:

• Shows up at 7am when you tell him

• Uses your tools, ladders, and truck

• Works on every job

• Gets paid $25/hour every Friday

• Was trained your way

• Has no other clients

Verdict: Employee. You control when, where, and how he works.

Clearly a Subcontractor

HVAC subcontractor who:

• Bids the job ($8,500 for full install)

• Brings their own crew, tools, and van

• Works for five other GCs

• Has an LLC and insurance

• You give specs and deadlines

Verdict: True subcontractor.

Grading contractor who:

• Mobilizes their equipment

• Charges by the job

• Works unsupervised

• Has multiple clients

Verdict: True subcontractor.

The Problem: Gray Zone Workers

Contractors don’t get in trouble classifying licensed trades as subs.
They get in trouble with helpers, laborers, and “one-man subs” who only work for them.

3. The Gray Zone — And How to Structure It Safely

Here are the four rules that keep you out of trouble:

Rule 1: Hourly Workers Are Almost Never Subs

If you’re paying someone hourly and supervising them → that’s an employee.

Example of what NOT to do:
A “subcontractor” drywall finisher who:

• Works only for you for 8 months

• Shows up when you tell him

• Uses your scaffolding

• Gets paid $300/day every Friday

• Has no other clients

• Has no business entity

Verdict: Employee — no matter what you call him.

Cost of getting it wrong:
We saw this exact setup reclassified during a state audit. The contractor owed $8,400 in back payroll taxes — for one worker.

Rule 2: Helpers Need Special Attention

If a helper only works for your company, uses your tools, and follows your foreman → employee.

Rule 3: One-Man “Subs” Must Look Like Businesses

A legitimate one-person subcontractor should:

• Have their own tools

• Invoice you, not get a “paycheck”

• Work for multiple contractors

• Carry GL insurance

• Provide their own workers’ comp

• Or a valid exemption — in many states, sole proprietors with no employees can file a workers’ comp exemption certificate. Ask for it. It proves they’re legally exempt.

• Have a business entity

Rule 4: Don’t Blur the Relationship

Avoid:

• Having subs report to your foreman for daily tasks

• Putting subs on your employee schedule

• Letting subs borrow most of your tools

• Training subs on your methods

Example:
If your foreman texts a “sub” every morning with that day’s task list, that’s not independent subcontracting — that’s supervision.

Reality:

If someone looks, acts, and gets treated like part of your crew, the IRS will almost always call them an employee.

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When to Just Hire Them as an Employee

If you need someone full-time, exclusively, under your supervision → hire them as W-2.

Quick math:

• Paying someone $50K as a 1099 saves you $8K–$10K

• A reclassification audit costs that $8K–$10K + penalties + interest

• One audit wipes out years of “savings”

And here’s the part most contractors never think about:
The IRS isn’t the only one who punishes misclassification.
Your insurance company does too — and the bills can be even bigger.

4. Insurance Implications Contractors Don’t See Coming

Misclassification creates insurance problems that can cost tens of thousands.

Workers’ Comp Audits

Your carrier reviews your 1099 payments.
If your “subs” don’t have their own workers’ comp?

They get treated as your employees — and you get the bill.

Real example:
A framer paid $180K to three “subs” without workers’ comp.
Audit bill: $31,000.

Workers’ comp trusts certificates — not verbal claims.

General Liability Exposure

If a “1099” gets injured or hurts someone else:

• Workers’ comp may deny it (“You said he was a contractor.”)

• GL may deny it (“He looks like an employee.”)

Real example:
A concrete contractor had a “sub” break his leg.
Workers’ comp denied (you classified him as 1099).
GL denied (they said he was really an employee).
He paid $68,000 in medical bills out of pocket.

What You Need From Every True Sub

• Certificate of insurance (GL)

• Proof of workers’ comp or exemption

• W-9

• Written contract spelling out independence

  Treat subs like businesses — on paper and in practice.

Closing: Don’t Let the IRS Make the Decision for You

Misclassification is a silent risk that hits you months or years later — with audits, penalties, back pay, and higher insurance premiums.

Do this one thing this week:
Pull your 1099 list from last year.
Ask: “If the IRS audited me tomorrow, would they agree this person is a contractor?”

If the answer is no, fix it now.

When the IRS makes the call, you’re already writing the check.

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