Contractor tax debt: worker classification, 1099s and payroll

The IRS looks at behavioral control, financial control and the relationship of the parties to decide whether a worker is an employee — see independent contractor or employee. Crew members who work set hours, use your tools and work only for you can look like employees. If reclassified, the business can owe the payroll taxes it should have withheld and paid, plus penalties. See worker misclassification.

Businesses generally file Form 1099-NEC for each nonemployee paid $600 or more for services in the year (the threshold rises for payments after 2025 — check the current instructions). If a subcontractor won't give you a correct taxpayer ID, you may be required to apply backup withholding to payments and deposit it — and unpaid backup withholding becomes a business tax debt.

Contractors are often paid on draws or after completion, while payroll runs weekly. Missed deposits during slow stretches add failure-to-deposit penalties and, if repeated, draw a revenue officer. Sole proprietors and pass-through owners who skip estimated payments in good years end up with large individual balances in April.

Whether a contractor pays tax on materials when buying them or collects it from customers depends on the state and the type of contract. Materials bought out of state without tax can create use tax liability. Check your state's sales tax page.

Get current on deposits first, then address past periods. If you've misclassified workers, ask a professional about the IRS Voluntary Classification Settlement Program before an audit. Use the payroll tax penalty calculator to see what's accrued and the free business tax relief assessment with "Contractor" selected.