Coordinated Counsel
Characterizing or Mischaracterizing Employees
Transcript
BARRY:
We have a new number 11, which we added last time. It’s bold. We’re both excited about it. It’s an interesting issue. And it’s the subject of a lot of games around how the law changes and how those games get played. So, number 11 is characterizing or mischaracterizing employees/1099s as independent contractors.
What’s the big deal? Why can’t we do that?
CHAD:
A lot of business owners, when they’re starting out, love to categorize people as 1099s because they don’t have to pay payroll tax on them. No Social Security, no Medicare. And we find that’s why business owners do it a lot of times. But the IRS will eventually realize that someone should be characterized as a W-2 employee. And if you’re not doing it correctly, they’re going to come back and come after you. Financially, that could mean a lot of unnecessary penalties and taxes that you’re going to owe down the road that are more severe than what you would have paid if you’d done things appropriately from the get-go.
The rules relate to how much the employee works. I’m sure you can elaborate on the legal requirements in terms of the classification distinction between the two. But financially speaking, it can really harm the business down the road in terms of depleting cash flow or other assets of the business to make up for their error.
BARRY:
Yeah, I agree with everything you just said. You can’t just choose what’s convenient. To go back– I think we mentioned in our last video that the law changed with the Affordable Care Act. Businesses were required to carry insurance if they were a certain size. I believe 50 employees or more.
So people started to– I guess people around, give or take 10, around 50, plus or minus– they started to re-characterize their people so they wouldn’t have to carry insurance, which is a huge financial commitment. Aside from the general gamesmanship that goes on to minimize taxes, that was a big driver that kind put this on the radar.
We could probably do a whole session on this topic, and we probably should. The IRS looks at it from a substantive point of view. They do not look at it by what you call yourself or what’s written in a contract.
CHAD:
Yeah, that’s one of the first things you learn in first year grad school: substance over form. Bringing back that lovely memory.
BARRY:
What I love about the law is that it’s substantive. The law is about the essence of things, not just what’s on the surface. So when you look at a person and their relationship with a company, you can put aside the labels all day.
What do they do? How do they do it? When and where do they do it? Under whose direction or control? Equipment? There’s so many levels of analysis that go into it. And of course if it gets audited, it’s like a colonoscopy. It’s going to be unpleasant.
CHAD:
Everyone knows how fun those are.
BARRY:
I will not speak on that one. But the bottom line is at the end of the day, there are savings if you’re a contractor in terms of payroll taxes. I think, just round numbers, it’s around 7.5% per employee. Roughly 15% total between employer and employee. But the penalties, interest, and potential criminal exposure if you get it wrong far outweigh those savings.
CHAD:
Payroll tax compliance is one of the most important issues right now, especially with the new executive order being proposed. And what that may do to businesses next year who don’t account for things correctly and what that might do to workers who think they’re getting bigger paychecks right now who will likely have to make up for it next year.
The Real Cost of “Playing the Contractor Game” in Your Business
By: Barry E. Haimo, Esq.
December 18, 2025
Most small business owners start with one goal: keep the lights on while building something sustainable. In the early stages, every dollar matters, and payroll taxes can feel like an easy place to “optimize.” That’s why so many entrepreneurs are tempted to classify workers as independent contractors rather than employees.
On the surface, it feels harmless. Less paperwork. Lower taxes. More flexibility. But lurking underneath is a problem that can quietly grow into one of the most expensive headaches a business will ever face: worker misclassification.
Why Misclassification Is More Than a Technicality
Labeling someone a 1099 contractor doesn’t make them one. And while the contract or title might feel like it gives you control, the law doesn’t look at the label — it looks at the reality of the relationship.
- How much direction do you give?
- Who sets the schedule?
- Whose equipment do they use?
- Are they integrated into your operations?
These questions — not your preference — drive classification. And if the IRS or Department of Labor decides your “contractor” is actually an employee, the consequences can be severe.
The True Financial Fallout
Misclassification is one of the few business mistakes that compounds over time. Employers caught on the wrong side of the line may owe:
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Back payroll taxes
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Unpaid overtime
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Interest and penalties
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Fines for failing to comply with wage and hour laws
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Potential liability for missed benefits
What started as a 15% “savings” can snowball into a legal and financial storm capable of draining cash reserves and destabilizing operations. Even businesses with modest revenue have found themselves writing five- and six-figure checks because of misclassification audits.
When “Everyone Does It” Doesn’t Hold Up
Many owners justify 1099 classifications by pointing to industry norms or competitors who do the same thing. But enforcement has been tightening for years. This became especially true after federal laws like the Affordable Care Act required certain employer benefits, and companies began shifting people into contractor status to avoid compliance.
That wave of reclassification triggered more scrutiny, and agencies caught on to the strategy quickly.
Now, with new federal rules and proposed executive orders targeting worker classification, enforcement is expected to increase even more. The businesses that will feel the most pain are those that assumed they were “too small” to be noticed.
It’s Not Just About Taxes, But Stability
A properly classified workforce protects more than your bottom line. It protects:
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Your business from disruption during audits
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Your employees from unexpected tax bills
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Your reputation in an era where labor compliance matters
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Your future growth (because investors and lenders care deeply about clean books)
Worker classification isn’t a box to check; it’s a foundational part of running a compliant, resilient business.
Bottom Line: Clarity Now Prevents Crisis Later
The short-term savings of calling someone a contractor rarely outweigh the long-term risk. If your business relies on people who look, act, and operate like employees, it’s time to make sure the structure you’re using reflects reality.
Adulting in business means playing the long game: choosing compliance over convenience, clarity over shortcuts, and sustainability over quick wins. And when it comes to worker classification, it’s one of the smartest long-game decisions a business owner can make.
Have questions or need help with classifying employees? Let’s talk.
