Any business paying some people through payroll and others by invoice should check those labels before the books close on 2026. Owners reach Lang Tax Solutions in late January with the same story: a contractor paid on a 1099 for three years who works set hours, uses company equipment, and reports to a supervisor. Fixing that in November costs an afternoon; fixing it after the forms are filed costs far more.
What decides whether a worker is a W-2 employee or a 1099 contractor?
Control decides it, not the paperwork. An employee is someone whose work the business has the right to direct; a contractor runs their own business and controls how the work gets done. A signed agreement does not settle it, and neither does the worker’s preference.
The IRS weighs three categories of evidence, laid out in Publication 15-A:
- Behavioral control. Who sets the hours, the task order, the location, and the methods? Training a worker on your procedures points toward employment.
- Financial control. Does the worker carry unreimbursed expenses, own their tools, stand to profit or lose, and serve other clients? Hourly pay with reimbursed expenses points toward employment.
- Type of relationship. Is the engagement open-ended, is the work central to what the business sells, and are there benefits such as paid time off?
No single factor controls the result. Form SS-8 gets a written IRS determination, but answers take six months or more, so it is no year-end tool. State law is often stricter: California’s ABC test under Labor Code section 2775 presumes employment unless the worker is free from control, works outside the hiring entity’s usual business, and is independently established in that trade.
Which arrangements get flagged most often?
The riskiest pattern is a long-term contractor with a single client. Close behind: a former employee rehired as a 1099 for the same job, admin staff paid by invoice, workers required onsite during fixed hours, and contractors issued a company email address and a staff-page listing. Most of these surface through a state unemployment claim, not an IRS audit.
What does misclassification really cost?
For unintentional misclassification, IRC section 3509 caps the assessment at 1.5% of wages for income tax withholding plus 20% of the employee’s share of FICA, on top of full employer FICA at 7.65%. On one worker paid $65,000, that runs near $6,900 before FUTA, interest, or state assessments. Three such workers across two open years pushes federal exposure past $40,000.
If the 1099s were never filed, those rates double to 3% and 40%. Penalties under sections 6721 and 6722 add several hundred dollars per form, and intentional disregard removes the annual cap. Unpaid withheld taxes can become personal liability for owners and officers under section 6672, at 100% of the trust fund portion. Add state unemployment insurance and back overtime under the Fair Labor Standards Act, and it stops resembling a tax adjustment.
What can still be fixed before December 31?
Quite a lot, because the reporting deadlines have not hit. Both 2026 W-2s and 1099-NECs are due to recipients and to the government by February 1, 2027, and anyone filing ten or more information returns in aggregate must file electronically. Confirm one change with your preparer: the 2025 tax act raised the 1099-NEC and 1099-MISC reporting threshold from $600 to $2,000 for payments made after December 31, 2025. That governs reporting only. Wages paid to an employee belong on a W-2 regardless of amount.
Four steps still work this quarter:
- List every non-payroll payee who received money for labor in 2026.
- Test each against the behavioral, financial, and relationship factors, and write down the reasoning.
- Get a current W-9 with a correct TIN for everyone staying on 1099.
- Move anyone who fails onto payroll effective a clean date, then fix the contract and the daily practice to match.
How does Lang Tax Solutions approach a classification review?
The review starts with how the work actually happens rather than what the agreement says. Two questions carry most of the weight: could this person do the same job for a competitor next week, and who controls how the work gets done? From there it turns to the state test, whether Section 530 of the Revenue Act of 1978 offers safe harbor relief, and whether voluntary correction beats waiting.
That last option is the IRS Voluntary Classification Settlement Program. Applying on Form 8952 means paying 10% of the employment tax liability computed under section 3509(a) for the most recent year, with no interest, penalties, or audit of earlier years for those workers. It requires consistent nonemployee treatment, filed 1099s, and no open examination.
Where this leaves you
Classification is a documentation problem as much as a tax problem. Businesses that come through audits cleanly wrote down their reasoning at the time, kept W-9s current, and treated contractors like vendors. If you are unsure where a worker belongs, or you already suspect the answer, Lang Tax Solutions can review your payee list and give you a defensible position before the January filings lock it in.
