How does the IRS decide if a worker is a contractor or an employee?

By the common-law rules, which look at three things: behavioral control (does the business control what the worker does and how), financial control (who controls pay, expenses, tools and materials, and who has a chance of profit or loss), and the type of relationship (contracts, benefits, how permanent it is, and whether the work is a key part of the business). No single factor decides it. The general rule is that a worker is a contractor if you can direct only the result, not what is done or how.

Is my helper an employee or a 1099 contractor?

Usually an employee. A helper who works the hours you set, rides in your truck, uses your tools and materials, works for you only, and is paid by the hour or day looks like an employee under every test the IRS and the states use. The IRS's own construction examples treat helpers and assistants working under a contractor's direction as employees. Registered apprentices are employees by definition.

What does misclassifying a worker cost?

If the IRS reclassifies a worker and the mistake wasn't intentional, you owe employment taxes at reduced rates under section 3509: in effect about 10.68% of wages up to the Social Security wage base when you filed the 1099s, higher if you didn't. Then add federal and state unemployment tax, workers' comp exposure, and any overtime the worker was owed as an employee. If the disregard was intentional, the reduced rates don't apply.

What is the IRS Voluntary Classification Settlement Program?

A program that lets a business start treating workers as employees going forward and settle the past for 10% of the employment tax it would owe under section 3509 for the most recent tax year, with no interest or penalties and no employment tax audit of earlier years for those workers. To qualify you must have treated them consistently as contractors, filed their 1099s for the previous three years, and not be under an IRS, Labor Department or state classification exam. File Form 8952 at least 120 days before you want to start.

Can a California subcontractor be a 1099 contractor?

Yes, under the construction subcontractor exemption in Labor Code section 2781, which takes the relationship out of the ABC test if every condition is met: a written subcontract, a contractor's license covering the work, any local business license, a separate business location, the power to hire and fire, financial responsibility for its own errors, and an independently established business of the same kind. Separately, work that requires a contractor's license can't be done by an unlicensed independent contractor.

Contractor or Employee? How Trade Shops Should Classify Helpers and Subs (2026)

The helper you pay by the day is almost certainly an employee. The licensed sub with his own truck, insurance and other customers, who bids the job and is told only what the result has to be, is probably a contractor. The IRS decides by control: if you direct only the result, it is a contractor; if you direct how, when and with what, it is an employee. The Labor Department's test leans the same way, and California and a few other states start from the assumption that every worker is an employee. Getting it wrong costs roughly 10.7% of the wages in federal employment tax for a year the IRS reclassifies, before unemployment, workers' comp and overtime. And there is a way to fix it for a tenth of that.

With 1099s due February 1, 2027, January is when this question gets asked. Here is how to answer it for a shop.

The IRS's three tests

The IRS uses the common-law rules, grouped into three kinds of evidence. No single one decides it; you weigh them together.

	Points to a contractor	Points to an employee
Behavioral control	Told only what result you need	Told when, where and how to work; trained in your methods
Financial control	Own tools, truck and insurance; pays own expenses; bids a flat price; can make or lose money; advertises and works for others	Uses your tools and materials; expenses reimbursed; paid by the hour, day or week
Type of relationship	A contract for a defined job; no benefits; the job ends	Ongoing with no end date; benefits; the work is the core of what your shop does

The IRS's general rule is short: a worker is an independent contractor if you have the right to direct only the result, not what is done or how. The right is what counts, whether or not you use it.

The IRS's own construction examples

IRS Publication 15-A works through cases that read like a trade shop's crew.

Helpers and assistants working under a contractor who approves them and inspects the work are employees of the contractor.
A worker the company supplies with materials, whose work it inspects, and whom it covers under workers' comp is an employee.
A roofer with a flat-price contract, his own business name and insurance, responsible for fixing his own mistakes, is an independent contractor.
A tradesperson paid a flat amount per job who advertises and takes other contracts is an independent contractor.

The pattern for a shop: subs who run their own business are contractors. People who work your jobs, your way, on your schedule are employees, whatever you call them.

Where the Labor Department's test stands in 2026

For minimum wage and overtime, the federal Fair Labor Standards Act has its own test, the economic reality of the relationship. Its status is unsettled:

The 2024 rule, with six factors (opportunity for profit or loss, investment, permanence, control, whether the work is integral to the business, and skill and initiative), took effect March 11, 2024, and is still the regulation on the books. It still applies in private lawsuits.
Since May 1, 2025, the Labor Department hasn't used it in its own enforcement. Investigators use its 2008 guidance instead, which names construction outright as one of the most common places workers are misclassified, and which says a state license has no bearing on the question.
In February 2026, the department proposed replacing the 2024 rule with a version of its 2021 rule, which weighs control and opportunity for profit or loss most. Comments closed April 28, 2026. As of November 2, 2026, there is no final rule.

Under any of these versions, a helper who works your schedule with your tools for an hourly wage is an employee.

State tests can be stricter

The IRS test isn't the only one that matters. Unemployment insurance and workers' comp are run by the states, and each decides classification under its own law.

California uses the ABC test. A worker is an employee unless the business proves all three: (A) the worker is free from its control, under the contract and in fact; (B) the work is outside the usual course of the business; and (C) the worker is customarily engaged in an independent business of the same kind. Prong B is the problem for a shop: an HVAC company hiring an HVAC tech fails it.

California has a construction subcontractor exemption in Labor Code section 2781. A sub falls outside the ABC test only if every condition is met:

The subcontract is in writing
The sub holds a contractor's license covering the work
The sub has any local business license or tax registration required
The sub has a business location separate from yours
The sub can hire and fire its own people
The sub takes financial responsibility for its errors, through insurance, bonds or warranties
The sub is customarily in an independent business of the same kind

California also makes a license a condition of contractor status: someone doing work that requires a contractor's license must hold one to be an independent contractor. An unlicensed helper doing licensed work can't be one.

Massachusetts and New Jersey use ABC tests too. New Jersey adopted detailed rules for its test that took effect in 2026. Texas decides unemployment-tax classification with a 20-factor common-law test focused on direction and control; a contract or a 1099 doesn't decide it.

What misclassification costs

If the IRS reclassifies a worker and the mistake wasn't intentional, section 3509 sets reduced rates for the back employment tax: 1.5% of wages for income tax you should have withheld, plus 20% of the employee's share of Social Security and Medicare, plus your full employer share. The IRS puts the total at 10.68% of wages up to the Social Security wage base ($184,500 for 2026). If you didn't file the 1099s, the first two rates double.

Three helpers paid $45,000 each in a year	Federal employment tax owed
1099s filed, not intentional	About $14,420 (10.68%)
No 1099s filed	About $18,510 (13.71%)
Intentional disregard	The full taxes, with no reduced rates

That is one year, federal only. On top of it:

Federal unemployment tax, normally $42 per employee a year after the state credit
State unemployment tax and any state penalties
Workers' comp. A misclassified worker hurt on a job can file a claim, and the state board decides whether they were an employee
Overtime. An employee is owed time-and-a-half for hours over 40 in a week. A helper on 50-hour summer weeks has back overtime coming
Benefits the employee would have been eligible for

Two ways out

Section 530 relief. If you treated the workers as contractors in good faith, the IRS can't make you pay the back employment taxes when all three are true: you filed their 1099s on time; you never treated anyone in a similar job as an employee; and you had a reasonable basis, such as court decisions or IRS rulings, a past IRS audit of the same workers, long-standing practice in a significant segment of your industry where you work, or advice from a CPA or attorney.

The Voluntary Classification Settlement Program. If you want to start treating workers as employees, this settles the past for 10% of the section 3509 tax for the most recent year, with no interest, no penalties, and no employment tax audit of earlier years for those workers. In the table's first row, that is about $1,442 instead of $14,420.

To qualify, you must have treated the workers consistently as contractors, filed their 1099s for the previous three years, and not be under an IRS employment tax exam or a Labor Department or state classification exam. File Form 8952 at least 120 days before the date you want to start treating them as employees. You pay after the IRS accepts and you sign the closing agreement.

The 1099s are the thread through both: filing them on time keeps your options open. That is one more reason to file them by February 1.

A shop's checklist

For each person you pay outside payroll, ask:

Do they have their own business? A business name, an EIN, a license for the work, their own insurance, other customers.
Do they bid the job or get paid by the hour? A price for a result points to contractor; an hourly or day rate points to employee.
Whose truck, tools and materials?
Who sets the schedule and the method?
Is it a defined job, or ongoing with no end?
Is the work what your shop sells? In ABC-test states, this one alone can decide it.

Mostly "their own" and "a defined job": a contractor, with a W-9 and a 1099-NEC if you paid $2,000 or more in 2026. Mostly "yours": an employee, on payroll. Unsure: ask your CPA, or file Form SS-8 and ask the IRS, which can take six months or more.

How Poof keeps both straight

Poof doesn't decide who is an employee; that is yours and your CPA's call. It keeps each kind of worker on the right side of the books.

For subs, Poof collects the W-9 at the first payment, keeps each one's year by how you paid them, and files the 1099-NEC with the IRS in January; the first 3 forms a year are free. For employees, Poof posts each pay run from your payroll provider's reports, ties the payroll withdrawals to it, and puts the labor on the jobs at what it actually cost. Timesheets, if you turn them on, record overtime with an append-only trail; your payroll provider pays it.

*General information, not tax or legal advice; your CPA and, for state law, an employment attorney have the final word.*

*Written by Austin Semple, a former controller: two years in audit, seven running the books for small businesses, and the founder of Poof. Poof keeps every sub's W-9 and 1099 and every tech's pay run on the books, side by side. Start free, no card required.*