1099 vs. W-2: Are Your Subs Actually Subs?

The shortcut that gets owners in trouble

Most trades businesses run into this question the moment they bring on their first helper:

"Should this person be W-2 or 1099?"

And most pick 1099. The reasoning is straightforward: W-2 employees cost 20–30% more once you add employer FICA, unemployment, workers' comp, and benefits. 1099 contractors handle their own taxes. You don't have to run payroll. Workers' comp gets simpler. "Everybody in trades does it that way."

The problem: the IRS doesn't care what you call them. They care about how the working relationship actually functions. And if they decide you misclassified an employee as a contractor, the back taxes, penalties, and interest can easily run $6,000–$8,000+ per worker, per year — multiplied by however long you've been doing it.

This guide breaks down the actual test, what changed for 2026, and how to think about it for your trades business.

Why this matters more for trades businesses

The IRS doesn't audit randomly. They target industries with high rates of misclassification.

Construction and trades are the #1 enforcement target. Always have been. The reasons are well-documented:

• Common practice of "1099ing" helpers and crew
• Many genuinely independent subcontractors operating alongside employees
• High labor turnover
• Cash-heavy operations historically
• Workers' comp avoidance is a known motivator

The IRS knows this. The Department of Labor knows this. The Texas Workforce Commission knows this. You're operating in the most-scrutinized industry for this issue. Worth getting right.

The IRS 3-Factor Test

The IRS uses three categories of evidence to determine classification. No single factor is decisive — they look at the whole picture. Full guidance at the IRS worker classification page.

Factor 1: Behavioral control

Question: Do you control HOW the work gets done — not just the result?

Pointers toward employee:

• You tell them when to show up
• You tell them what tools to use
• You tell them how to perform specific tasks
• You provide training
• You require specific procedures or methods
• You evaluate how the work is done, not just the result
• You provide the truck, tools, and equipment

Pointers toward independent contractor:

• They decide when, where, and how to do the work
• They use their own tools and equipment
• They've been hired for a specific result, not ongoing tasks
• No training provided — they're already skilled

The trades reality: If you're handing someone keys to your truck, telling them what time to be at the shop, dispatching them to jobs, and reviewing how they perform installations — that's behavioral control. That's an employee, almost regardless of what the contract says.

Factor 2: Financial control

Question: Do you control the business aspects of their work?

Pointers toward employee:

• They're paid on an hourly or daily basis
• You reimburse their expenses
• You provide tools and materials
• They have no real opportunity to profit or lose
• They work primarily or exclusively for you

Pointers toward independent contractor:

• Paid by the job with a fixed price
• Provides their own tools, materials, and vehicle
• Has an established business: license, EIN, insurance, marketing
• Works for multiple clients
• Can profit or lose money on the engagement

Factor 3: Type of relationship

Question: How do both parties perceive the relationship?

Long-term, ongoing engagement with no defined end → looks like employment. Project-based with a clear scope and end → looks like contractor work.

Important: Having a written "Independent Contractor Agreement" does NOT determine classification by itself. The IRS looks at the actual working relationship, not the paperwork. A contract that says "independent contractor" doesn't override behavioral and financial control in practice.

The trades-specific reality check

What changed for 2026 (OBBBA)

Two significant changes took effect in 2026 that trades businesses need to know:

1. 1099-NEC reporting threshold went up

For payments made in 2026 and later, you're only required to file 1099-NEC for subcontractors paid $2,000 or more in a calendar year (up from $600). Changed under the One Big Beautiful Bill Act (OBBBA), signed July 4, 2025.

Practical implications:

• For small one-off subcontractor jobs under $2,000, no 1099 required
• For substantial subcontractor relationships, you still file 1099 just like before
• This is a reporting threshold change — it does NOT change classification rules

Don't confuse these: The 1099 threshold is for reporting the payment, not for classifying the worker. A misclassified employee is still misclassified regardless of how much you paid them.

2. Section 530 safe harbor clarified

The IRS issued Revenue Procedure 2025-10 in January 2025 — the first comprehensive update to Section 530 safe harbor guidance since 1985.

Section 530 can protect businesses from reclassification penalties if they can show:

• They had a reasonable basis for treating workers as contractors
• They've been consistent in treatment
• They filed required 1099s

This safe harbor is more important than ever for trades businesses. If you're treating workers as contractors based on industry practice and consistent treatment, document everything — your reasoning, your 1099 filings, your contractor agreements — so you can invoke Section 530 if challenged.

This isn't a license to misclassify. It's a defense if your good-faith classification is later challenged.

What misclassification actually costs

If the IRS, DOL, or Texas Workforce Commission determines you've misclassified workers, here's what's on the table:

Rough estimate: $6,000–$8,000+ per misclassified worker, per year. A trades business with 4 misclassified workers over 3 years can easily be looking at six figures in back assessments — plus the loss of the worker's classification going forward, which means converting to W-2 anyway.

If you suspect misclassification or want a worker's status formally determined, the IRS provides Form SS-8 — but be aware that filing it almost always results in an employee determination.

How to stay on the right side of it

For workers you should treat as employees:

1. Run them through payroll (Gusto, QBO Payroll, or similar)
2. Withhold federal income tax, FICA; file Form 941 quarterly
3. Pay employer-side FICA, FUTA, and TWC unemployment
4. Carry workers' comp coverage (Texas doesn't require it, but operating without it exposes you to personal liability)
5. Issue W-2 by January 31
6. Track hours; pay overtime when due per the federal Fair Labor Standards Act

For workers who are legitimately independent contractors:

1. Collect a W-9 BEFORE paying them — non-negotiable
2. Verify they have a real business: EIN, insurance, license (if their trade requires one)
3. Use a written Independent Contractor Agreement
4. Have them invoice you
5. Don't provide tools, training, or detailed instruction on how to do the work
6. Pay by the job at a negotiated price, not by the hour
7. File 1099-NEC by January 31 if you paid them $2,000+ in 2026
8. Don't withhold their taxes

For the ambiguous cases

When in doubt, classify as W-2.

There's no penalty for treating a contractor as an employee (other than the extra cost). The penalties for the reverse can be severe. If the relationship looks 60/40 contractor-ish, that 40% can sink you in an audit.

The cost difference between properly classifying a $40K worker as W-2 vs. 1099 is roughly $4,000–$6,000 per year in employer taxes and overhead. The cost of getting that classification wrong, multiplied across multiple workers and multiple years, can be 10-20x that.

The math almost always favors paying the extra payroll cost upfront vs. gambling on classification.

Where Northbound fits

If you're an established trades business that's been "1099ing" workers for years and starting to wonder whether that's actually correct, this is one of the most valuable conversations a CPA can have with you — before the IRS does.

For Northbound clients on the Growth plan, worker classification review is part of the Compliance Package — we look at each subcontractor relationship, flag anything that looks like misclassification risk, and help you either restructure the relationship or convert to W-2 cleanly. The Payroll Oversight or Full Payroll Service add-ons handle the W-2 conversion when needed.

If you're not yet a client and this article made your stomach drop a little, that's actually the right reaction. Let's talk.

Book a free 30-minute discovery call

Related reading

• The Complete Financial Playbook for Texas Trades Businesses
• Sole Prop vs. LLC vs. S-Corp for Trades Businesses
• Self-Employment Tax Explained for Trades Businesses
• Job Costing in QuickBooks for Contractors

Classification rules, OBBBA provisions, and penalty figures cited are based on 2026 federal tax law and IRS Revenue Procedure 2025-10 as of publication. State rules vary; Texas Workforce Commission rules can be found at twc.texas.gov. Worker classification is a fact-specific analysis — nothing in this article constitutes legal, tax, or financial advice for your specific situation. Consult a qualified CPA or labor attorney before making classification decisions.