- The IRS looks at behavioral control, financial control and the nature of the relationship
- Several states, including California, New Jersey and Massachusetts, apply a stricter ABC test where failing any one part makes them an employee
- A signed contractor agreement helps but does not decide it
- Get a W-9 before you pay anyone, not in January when you need to issue the 1099
- Back taxes, penalties, unpaid overtime and workers comp exposure all follow a wrong call
California applies the ABC test, and you have to satisfy all three parts. You fail A on control, since you set the hours and supply the tools. You likely fail B, since the work is your core business. C is irrelevant once A has failed.
What exposure looks like: back payroll taxes, unpaid overtime and meal break premiums, workers compensation exposure for any past injury, and penalties. It usually surfaces when someone leaves unhappy, which is the worst moment.
Reclassify before that happens. Want me to work through what it costs to do it properly?
Advanced engine. It gave you a straight answer instead of hedging, because the facts were clear.
One worker, four tests
The IRS applies the common-law control test, the Department of Labor an economic-reality test, and your state its own tests for unemployment insurance, wage law and workers comp. Pass the strictest one that applies. In California a worker is an employee unless you prove all three ABC prongs, and willful misclassification costs $5,000 to $15,000 per violation, or $10,000 to $25,000 for a pattern. As of Oct 2026.
Rev. Rul. 87-41; Cal. Lab. Code secs. 2775 and 226.8
The 1099-NEC and the W-9
For payments made from January 1, 2026, file Form 1099-NEC for $2,000 or more of nonemployee compensation paid to a noncorporate contractor, up from $600. The 2026 forms are due February 1, 2027, because January 31 is a Sunday. Card payments are reported on Form 1099-K instead. If a contractor will not give you a valid W-9, withhold 24% from future reportable payments. As of Oct 2026.
IRS Instructions for Forms 1099-MISC and 1099-NEC; IRC sec. 3406
| Employer payroll tax on $240,000 of pay, at an assumed 10% blended rate | $24,000 |
| Misclassification penalties if found willful, at least $5,000 for each worker | $20,000 |
| Exposure before back overtime, workers comp premium and waiting-time penalties | $44,000 |
Misclassification is discovered when the relationship ends badly, which is exactly when it is most expensive.
If you got it wrong in good faith, Section 530 relief or the IRS Voluntary Classification Settlement Program can limit back taxes in some cases, and Form SS-8 asks the IRS to decide. Talk to GRACE before the relationship ends, not after.
I use contractors in [state] who [describe how they work: their hours, their equipment, whether they work for others]. Run the classification test honestly and tell me whether they are really contractors.
Every lesson ends with a question to hand to a Greymill specialist, who answers with what it knows about your business.