Subcontractor vs employee: how the IRS decides
Paying someone as a 1099 employee doesn't make them a subcontractor. Under IRS rules, a worker is your employee if you have the right to control what gets done and how it gets done, even when you give them room to work their own way. A subcontractor is someone you direct only on the result: they run their own business, use their own methods and can take other customers. The form you file follows the relationship, not the other way around.
That matters in the trades because the setup that looks cheapest, a tech in your shirt and your truck on your dispatch board, paid on a 1099, can fail the IRS test on almost every factor. Here's the test, what it looks like on a crew, and what getting it wrong costs.
What's the difference?
The IRS puts it in one sentence: someone is an independent contractor if "the person for whom the services are performed has the right to control or direct only the result of the work and not what will be done and how it will be done" (IRS). Subcontractors are on its list of people who are generally independent contractors, when they're in an independent trade offering their services to the public.
On a home service crew, that looks like this:
- A subcontractor is another business. It bids the job, brings its own crew and tools, carries its own insurance, invoices you and can lose money on the work.
- An employee works in your business. You set the schedule, supply the truck and tools, train them your way and pay them for their time.
- A "1099 employee" is just a payment label. If the facts say employee, the IRS treats the person as one "regardless of what the relationship is called."
The IRS test, with trade examples
The IRS sorts the evidence into three categories and says there is no "magic" or set number of factors (IRS). Here's what each one looks like in a home service company.
| IRS category | Points to an employee | Points to a subcontractor |
|---|---|---|
| Behavioral control: who decides how the work gets done | Your office sets when and where they work and the order of the job; you train them on your methods | They decide how to do the job; you inspect only the finished work |
| Financial control: who runs the money side | You supply the truck, tools and materials; they're paid by the hour or week; they work only for you | They own their truck and equipment, pay their own expenses, bid a flat price, advertise and work for others |
| Type of relationship: how both sides see it | Open-ended, doing your core service, with benefits like paid time off | A defined project or scope, a written contract, no benefits |
Two IRS details catch trades owners. Owning tools doesn't settle it: "in many occupations, such as construction, workers spend thousands of dollars on the tools and equipment they use and are still considered to be employees" (IRS). And a signed contract doesn't settle it either: "How the parties work together determines whether the worker is an employee or an independent contractor" (IRS).
A quick check for each 1099
Answer these for everyone you pay on a 1099. The more yeses, the more the person looks like an employee:
- Do they wear your shirt and drive your truck?
- Does your office set their schedule and dispatch their calls?
- Did you train them on how you want the job done?
- Do you pay them by the hour, day or week?
- Do they work only for you, with no customers of their own?
- Do they do the main service your company sells?
- Has it been going on with no end date?
A tech who answers yes to most of these is an employee with the wrong paperwork. An electrical contractor you bring in to run a circuit for a mini-split, who bids the job, carries insurance and works for other shops, is a subcontractor. If you run W-2 crews alongside 1099 painters, our painting contractor bookkeeping tracks sub payments all year so the 1099 totals are ready in January.
The 1099 sales team at a pool company
Brandon Vaughn, who coaches home service owners, worked through this with a pool company whose salespeople were all on 1099s. The owner asked whether they were safe under "the 70% rule." Brandon's answer:
Rule of thumb is they can't make more than 70% of their annual income from one single source, 1099. Otherwise, red flag to the IRS come knocking on your doors. The other part of it is licenses, insurance. You can't dictate their schedule to them. You can't tell them what to wear. They're not driving company cars.
Keep the IRS rule and Brandon's rule of thumb apart. The 70% is his number; the IRS has no percentage test. It does weigh whether a worker's services are available to the market, which is what his screen gets at. The second half of his answer, schedule, dress and company cars, lines up with the IRS behavioral and financial factors.
The owner decided to move the reps to W-2. When they role-played the hiring conversation, Brandon gave his reason for hiring salespeople as employees:
a lot of companies that do 1099 positions, they're breaking the law because they're still treating their salespeople like employees, dictating their schedule
What misclassification costs
Paying an employee on a 1099 skips the employer's side of payroll. Here's an example for one tech at $25 an hour working 2,000 hours in 2026. The state unemployment and workers' comp lines are examples; your rates depend on your state and job class.
| Employer cost a 1099 skips | Basis | Annual |
|---|---|---|
| Social Security | 6.2% of $50,000 | $3,100 |
| Medicare | 1.45% of $50,000 | $725 |
| Federal unemployment (FUTA) | 0.6% of the first $7,000, after the state credit | $42 |
| State unemployment | example | $300 |
| Workers' comp | example, $6 per $100 of payroll | $3,000 |
| Total | $7,167 |
That's about 14% on top of wages, or roughly $36,000 a year across a 5-tech crew. Our labor burden post shows the full employer cost per hour.
If the IRS reclassifies the worker, the federal side comes back to you. The IRS says that if you treat an employee as an independent contractor "and you have no reasonable basis for doing so, then you may be held liable for employment taxes for that worker," and points to Internal Revenue Code section 3509 for how that's figured. Interest and penalties can come on top. The Labor Department runs its own test for minimum wage and overtime, asking whether the worker is "economically dependent on the employer for work," and notes that "a worker who is paid off the books or receives a 1099 is not necessarily an independent contractor" (DOL Fact Sheet 13). That test is in flux. In May 2025 the department told its investigators to stop applying its 2024 rule and use the 2008 version of Fact Sheet 13 instead (Field Assistance Bulletin 2025-1), though the 2024 rule still governs private lawsuits, and in February 2026 it proposed a new rule. The factors that matter most, like who controls the work and whether the worker can make or lose money, appear in every version. Your state may have its own test as well.
How to set up a real subcontractor
If the person does run a business, make the paperwork match:
- Get a W-9 before the first payment. The IRS calls it the first step once you've decided the worker is an independent contractor.
- Get a written scope and price for each job, and an invoice when it's done.
- Keep their insurance certificate and, where your state licenses the trade, a copy of the license.
- Pay from a bill, booked to subcontractors in cost of goods sold, never through payroll.
- File Form 1099-NEC (the 2026 1099 rules cover who gets one). For payments made in 2026, file one for each sub you paid $2,000 or more for services, due to the IRS and the sub by February 1, 2027 (IRS instructions). Payments to a corporation, including an LLC taxed as one, are generally exempt.
Filing those 1099s matters beyond the deadline. The IRS says that to qualify for Section 530 relief, the protection for businesses that had a reasonable basis for treating someone as a contractor, "employers must file Form 1099-NEC."
When you're not sure
- Ask the IRS. Either you or the worker can file Form SS-8, and the IRS will "officially determine the worker's status," though "it may take at least six months."
- Fix it going forward. If you already have employees on 1099s, the Voluntary Classification Settlement Program lets you move them to payroll for future periods with partial relief from federal employment taxes. You apply on Form 8952.
- Get local advice. A CPA or employment attorney who knows your state can tell you where its rules differ.
When someone moves to W-2, run them through payroll from the first check. We run payroll in the same house as your books, so their wages land in the right cost line from the first check (how it works); our post on payroll service vs in-house covers the trade-offs. If you have subs who look like employees, bring the list to a free profit call and we'll go through it with you.
FAQ: subcontractor vs employee
Is a 1099 employee a subcontractor?
No. "1099 employee" only describes how someone is paid. If you control how and when they work, the IRS treats them as an employee whatever form you file.
Can a subcontractor work only for me?
Nothing forbids it, but it weakens the case. The IRS looks at whether a worker's services are available to the market, and a sub with no other customers who works your schedule looks like an employee.
Does forming an LLC make someone a subcontractor?
No. The IRS looks at how you work together, not the paperwork. An LLC taxed as a corporation does change the 1099 side, since payments to corporations are generally exempt from 1099-NEC reporting.
What's the 1099-NEC threshold for 2026?
$2,000 for payments made in 2026, up from $600 for payments through 2025.
