Handing someone a 1099 instead of putting them on payroll feels like the simpler, cheaper move. No payroll taxes, no withholding, no benefits — you just pay the invoice and move on. That’s exactly why it’s one of the most expensive mistakes I clean up.
Here’s the problem: you don’t get to decide whether a worker is a contractor or an employee. The law decides, based on how the work actually happens. Call it wrong and the bill that lands later is far bigger than the payroll taxes you skipped.
Why the IRS cares so much
When you pay a real employee, you withhold their income tax, you withhold and match Social Security and Medicare, and you pay federal and state unemployment tax. When you pay a contractor, all of that disappears — the worker is supposed to handle their own taxes. So every time a business labels an employee a “contractor,” the government collects less. That’s why this is a perennial audit target, at both the IRS and the New York State level.
The test: it’s about control
Forget the title on the agreement. The IRS looks at the real relationship across three buckets — and the through-line is control.
Behavioral control. Do you tell them when to show up, how to do the job, what order to do it in, what tools to use? A contractor decides how to deliver the result. An employee follows your direction.
Financial control. Do they have their own business — other clients, their own equipment, the ability to make a profit or take a loss? Or do they depend on you for steady pay and you cover the costs? Real contractors carry business risk.
Type of relationship. Is it open-ended and ongoing, with you treating them like part of the team? Or is it a defined project with an end? The more permanent and integrated, the more it looks like employment.
No single factor wins. The classic red flag: a full-time “contractor” who’s worked only for you for two years, uses your equipment, follows your schedule, and gets a 1099 every January. On paper they’re a contractor. In reality, the IRS will call them an employee — and so will the New York Department of Labor.
What it costs when you get it wrong
This is where the numbers get ugly. Say you paid a misclassified worker $60,000 over a year. If the IRS reclassifies them, you can be on the hook for the income tax you should have withheld, both halves of Social Security and Medicare, federal unemployment, plus penalties and interest stacked on top. There are reduced penalty rates under a provision called “Section 3509” — but those reduced rates roughly double if you didn’t file the 1099 in the first place. Add New York’s own assessment for unpaid state unemployment and withholding, and the exposure on a single worker can run well into five figures. Now multiply that by every person you’ve classified the same way. That’s how a “simpler, cheaper” decision turns into a number that threatens the business.
The safe harbor most owners have never heard of
There’s a real escape hatch called “Section 530 relief.” If the IRS comes after you, you can avoid the back employment taxes if you can show three things: you filed all the required 1099s for those workers on time, you treated everyone in that role consistently as contractors (you can’t put one person on payroll and 1099 the next identical role), and you had a reasonable basis for treating them as contractors — like a longstanding practice in your industry, a prior audit that didn’t challenge it, or court rulings supporting it.
The IRS refreshed its guidance on this relief in early 2025 — the first real update in decades — so the bar for documenting your reasonable basis matters more than ever. Translation: file your 1099s, be consistent, and keep notes on why you classified the way you did. That paperwork is what saves you.
If you genuinely can’t tell, either party can file Form SS-8 and ask the IRS to make the call directly. It’s binding, but it takes six months or more — so it’s a planning tool, not a fix for a fire that’s already burning.
The bottom line: the contractor-versus-employee call isn’t a preference, and it isn’t settled by what the worker prefers either. Get it right going in. If you’ve already got people you’re not sure about — and if any of them are working in another state, the stakes climb higher, which I covered in the multi-state payroll reality — have someone look before the notice arrives. This is the kind of thing that’s quietly expensive until it’s suddenly catastrophic.
Geiger Tax & Accounting is based in Amityville, NY and works with business owners nationwide. This article is general information, not tax or legal advice for your specific situation. Worker classification turns on the full facts of each relationship — talk to a professional before making changes. Reach us at (631) 532-5622 or info@geigertax.com.