You do not get to pick. That is the part every page ranking for this question buries or skips.
Whether the next person on your jobs is a subcontractor or an employee is a question of fact about how the work actually happens, settled later by an auditor reading your job files. The IRS, your state unemployment agency, your comp carrier and the CRA each run their own version of that test, and none are bound by what your paperwork says.
So the useful question is not "which one should I hire," but "what does this work actually need to look like." Getting that order backwards is how contractors end up with a five figure assessment for a helper they paid $22 an hour.
The short answer
Subcontract work that is a defined scope, priced as a job, done by a business that carries its own insurance and works for others. Put on payroll anyone whose hours you set, whose method you direct, and whose tools come off your truck.
That is not a preference. It is a description of the two legal categories, and almost every hiring decision in the trades resolves cleanly once you state the work honestly. The framer who prices your rough carpentry, brings a crew and a nail gun, and is on someone else's job next week is a subcontractor. The helper who meets your lead at the shop at 7am, uses your ladders and does what he is told is an employee. There is no third box, and the second person is usually the one you actually need.
You do not actually get to choose
The IRS weighs evidence in three buckets: behavioral control, financial control, and the type of relationship. Its guidance is blunt that "there is no magic or set number of factors," and that the keys are "to look at the entire relationship and consider the extent of the right to direct and control the worker."
The Canadian test says it more sharply. The CRA's guide on employee versus self employed status states that "it is the right of the payer to exercise control that is relevant, not whether the payer actually exercises this right."
Read that again, because it is the sentence that catches trades operators. You do not have to micromanage anyone. If you could tell them how to do it, that is control.
An HVAC operator described his arrangement on r/Construction without appearing to notice what he was describing: "my subs only work for me since I can keep them busy. They might get a handful of days off a year." Exclusive, continuous, full time work under one payer is close to the textbook profile of employment. He has employees. He calls them subs.
A contractor in the same discussions put the test in job site language: "If you tell them when to show up, provide them tools, or tell them how to accomplish the end product (plus many other things), they are NOT independent contractors."
The gap between how crews are described and what they legally are is not small. A Century Foundation study using 2021 data estimated that up to 2.1 million U.S. construction workers, close to 20% of the construction workforce, are misclassified or paid off the books.
Watch out
State rules can be stricter than the federal test, and some are absolute. An Oregon contractor noted that in his state you cannot 1099 someone unless they hold their own license, full stop, because the point of the rule is to stop people avoiding workers comp. As one operator put it, this is "two totally different questions in Montana and California."
The saving is smaller than you think
Here is the arithmetic almost nobody runs first.
A Pennsylvania contractor worked it out publicly. Paying $25 an hour W2, he added roughly $2.50 an hour of workers comp and 7.65% FICA, landing near $29.40 an hour of employer cost, with the worker netting about $22.34 before income tax. To get that worker to a genuine $25 net, he calculated he would need to pay about $32 an hour.
Then he ran the 1099 side. The same worker as an independent pays 15.3% self employment tax, state tax, and carries his own insurance. To net the same $25, he needs to charge about $32 an hour.
Same number. His question was the honest one: "Is there something I'm missing here?"
He was not missing much. A commenter answered it cleanly: "from a pure math view, to get someone to the same net, 1099 usually isn't magically cheaper, it just hides the true labor cost."
The burden does not disappear when you 1099 someone. It moves onto their invoice, or comes quietly out of their pay because they did not know to charge for it. Another operator priced the honest version: a genuine independent "should be charging you $40/hr to net $25/hr above board, assuming liability insurance."
So when a 1099 arrangement looks 30% cheaper, either the worker is absorbing the burden unknowingly, which is a turnover and lawsuit problem, or you are absorbing it later at audit. If neither is true, the person priced it in properly and you saved nothing.
| Employee | Genuine subcontractor | |
|---|---|---|
| Who carries payroll tax | You | Them, priced into the rate |
| Who carries workers comp | You | Them, verified by COI |
| Who owns cost overrun | You, by the hour | Them, on a fixed price |
| Who owns the schedule | You | Shared, negotiated |
| Non billable time | You pay for it | Not your problem |
| Correct rate for a $25 net | About $32/hr loaded | About $40/hr invoiced |
The genuine advantage of a subcontractor is not the payroll tax. It is risk transfer. A fixed price for a defined scope moves the overrun onto whoever is best placed to estimate it. As Michael Stone of Markup and Profit puts it, specialty contractors "can more accurately estimate how long a job will take," and "the price they quote will be the price you pay for the work, reducing your risk of a cost overrun on that part of the job."
That is a real reason to sub. Dodging FICA is not.
What being wrong actually costs
Most articles say the penalties are "steep" and leave it there. The IRS publishes the exact rates in its own examiner manual.
When workers are reclassified as employees and you filed Forms 1099-NEC on time, IRC 3509(a) applies. Per the Internal Revenue Manual at 4.23.8.5.1:
| Component | Rate |
|---|---|
| Employer share of FICA | 7.65% |
| 20% of the employee share of FICA | 1.53% |
| Federal income tax withholding | 1.50% |
| Total | 10.68% of wages |
If the required 1099-NEC forms were not filed, IRC 3509(b) applies instead: the withholding rate becomes 3%, and FICA becomes the employer share plus 40% of the employee share, for a total of 13.71% of wages.
Two details make this worse than the headline. The manual notes that application of IRC 3509 "is mandatory if the criteria are satisfied," and that the offset relief under IRC 3402(d) and 6521 does not apply. More importantly, IRC 3509 does not apply at all where the liability is due to intentional disregard. Those reduced rates are the floor for someone who made a defensible mistake. Deliberately papering an employee as a sub puts you outside them, into the full unwithheld amount plus failure to file, failure to pay and failure to deposit penalties.
That is only the federal tax layer. State agencies run parallel and often move faster. A California contractor described a state employment development department audit in plain terms:
"Everything you pay your subs will count as payroll, and will be assessed back taxes, interest, and penalty. Just went through an EDD audit last year and assessed fine of 134k. These guys don't play around... Everytime you pull a permit, there's a chance they'll come visit your jobsite."
$134,000 is not a rounding error on a small contracting business. It is the business.
The reason most operators reach for a 1099 helper is that the work is lumpy and they cannot promise anyone forty hours. That is a demand problem wearing a hiring problem's clothes. Pavado builds lead generation for local service businesses with a conversion page, a qualifying form and lead-to-sale tracking, so the pipeline is steady enough that payroll stops being a gamble.
The workers comp audit arrives first
The tax exposure is the one people worry about. The insurance exposure is the one that actually shows up, usually within twelve months, and it requires nobody to accuse you of anything.
At your annual premium audit, any subcontractor you cannot document as insured is treated as your payroll. The formula is mechanical:
Audit exposure = subcontract amount × labor ratio × (class rate ÷ 100) × your EMR
The labor ratio is the part that catches people. If your invoice does not itemize labor separately from materials, auditors apply a mandatory default split, typically 50%, and up to 100% where labor is unsegregated. Worked through standard class rates and a 1.10 experience modifier, that produces bills like these:
| Uninsured sub | Invoice | Labor basis | Back premium |
|---|---|---|---|
| Residential framing | $50,000 | $25,000 | about $4,538 |
| Roofing | $40,000 | $20,000 | about $5,456 |
| Drywall | $35,000 | $17,500 | about $1,771 |
| Electrical | $25,000 | $12,500 | about $798 |
Note what is not in that formula: any finding that you misclassified anyone. You can be entirely right that your framer is an independent business and still pay this, purely because you did not collect a certificate before cutting the cheque.
The trap that bites hardest is the solo operator. From the auditor's chair, an unexempted sole proprietor on your site is an uninsured direct employee, and 100% of what you paid him becomes auditable payroll. Escaping that needs a state issued exemption certificate, or an active ghost policy naming the owner as excluded.
A Colorado operator gave the working version: "you have to document every sub on site has Workers Comp or get a signed and notarized Exemption. If you can't prove they had workers comp when they were on site you will get charged for insuring them." The operational fix is boring and effective: gate the payment, not the site access. We walk through the system in tracking subcontractor insurance certificates.
Tip
One legitimate lever most small operators miss, from a contractor who uses it: workers comp class rates vary enormously by trade, and drywall, painting, electrical and plumbing rates are often far below carpentry. Having crew clock in under the trade they actually performed that day, rather than defaulting everyone to the highest rated code, is a real and legal premium reduction. Your bookkeeper can set it up.
Federal law is getting friendlier and it will not save you
In early 2026 the Department of Labor proposed rescinding the 2024 independent contractor rule and replacing it with a framework closer to the 2021 approach, elevating two factors above the rest: the nature and degree of control over the work, and the worker's opportunity for profit or loss. The comment period closed April 28, 2026.
The trade press framed it as relief. Treat it as noise, for three reasons.
It is a proposal, not a rule. It has not been finalized, and this rule has now swung with three consecutive administrations.
It only governs federal wage law. It reaches the FLSA and related statutes, explicitly does not affect state law, and does not bind courts. The strict state tests, including the ABC tests several states apply to construction, are untouched.
It is not the test that costs you money. The IRS runs the common law control test, your carrier runs the certificate rule, and the CRA runs its own six factor analysis. A friendlier federal wage rule changes none of them.
Besides, the two factors the proposal elevates, control and opportunity for profit or loss, are the two that already sink most trades arrangements. A helper paid hourly with your tools has neither. Under either version of the rule, he is an employee.
The Canadian version
If you operate in Canada the mechanics differ and the shape of the bill does not.
The CRA uses a two step approach. First, what did the parties intend: a contract of service, meaning employment, or a contract for services. Second, and decisively, do the actual working conditions match that intent. It then weighs six factors: control, tools and equipment, whether the worker can subcontract or hire assistants, financial risk, responsibility for investment and management, and opportunity for profit. On the last, the guide is direct: "employees normally do not have the chance of a profit and risk of a loss."
Getting it wrong is costed plainly on canada.ca. An employer who fails to deduct the required contributions "has to pay both the employer's share and the employee's share of any contributions and premiums owing, plus penalties and interest." On top sits a 10% penalty on amounts not deducted or remitted, rising to 20% where the failure was knowing or grossly negligent, under CPP subsection 21(7) and Income Tax Act subsection 227(9.1). Then the provincial layer arrives separately: WSIB reassessing premiums, and employment standards obligations for vacation pay, notice and overtime a "contractor" was never given.
The four gates
Run any specific hire through these in order. If it fails a gate, it is an employee, and the remaining gates do not matter.
Gate 1: Scope. Can you write a defined outcome and a price before the work starts? "Rough in the second floor for $6,800" passes. "Help my lead with whatever we have on" fails.
Gate 2: Continuity. Is this a job with an end, or is it your Tuesday, every Tuesday, indefinitely? Continuous full time engagement with one payer is the pattern auditors look for first, and exclusivity is the aggravating factor.
Gate 3: Control. Who decides the hours, the sequence, the method and the tools? If the honest answer is you, or would be you the moment you cared to decide, the gate is failed.
Gate 4: Coverage. Do they carry their own general liability and workers comp, or hold a valid state exemption, and can you produce the certificate today? If not, they are your payroll at audit whether or not the first three gates passed.
A pass on all four is a subcontractor. Anything else goes on payroll, and you price the work accordingly.
What good operators actually run
Ask experienced operators and the answers converge on one structure, not on either pure model. The highest voted answer in a 2026 r/Construction discussion on exactly this question:
"You need a core crew who can handle the majority of the work. Bring subs in for efficiency with specialty tasks so they get finished quicker and you have less worry if that's their specialty."
The reasoning is not sentimental. A remodeler in the same thread named what disappears when you have no employees at all: the out of scope work, which "either becomes a change order, or more work for you to do." Somebody has to do the twenty things falling between the subs' scopes, and if that somebody is the owner, you have bought yourself a job.
The counter case is just as real, and it is about utilization rather than law. One operator ran 5 to 7 employees, hit $3,000 a month in workers comp alone on top of accounting and CPA costs, and went back to subs. His summary of the employee years: "I was more of a baby sitter and coach, and less of the craftsman I am." Another drew the line simply: do not take on an employee "unless you have enough work where you really have a need for someone to work for you a solid 40 hours a week for the next year."
That is the real crossover, and it is a demand question. An employee is a fixed cost that only pays for itself at high utilization. A subcontractor is a variable cost you can turn off. If your pipeline is lumpy, subs are correct, and the honest version means real businesses on defined scopes, not a helper with a 1099. If it is full and predictable, payroll is cheaper per billable hour and buys consistency, availability and a story you can sell: "All subs is a PR nightmare, there's some sales cachet to having your own crew."
The decision checklist
Before you commit either way, answer these:
- Can I state this work as a scope and a price, or only as hours?
- Do I have twelve months of work to keep this person busy, or three?
- Whose tools, whose truck, whose schedule?
- If an auditor asked why this person is not an employee, what is my evidence beyond the contract?
- Do I hold a current certificate or valid exemption for every sub on site this policy year?
- Have I priced the job at loaded cost, roughly $32 an hour for a $25 an hour employee, or at the wage?
- Am I choosing a sub because the work is genuinely a scope, or because I cannot afford payroll? If it is the second, the problem is upstream.
The bottom line
The question contains a false premise, and the false premise is the expensive part. You are not choosing a tax treatment. You are choosing how the work is structured, and the tax treatment follows automatically, whether you cooperate or not.
Structure work as defined scopes bought from real businesses and subcontracting is correct, cheaper in risk, and audit proof. Structure it as your schedule, your tools and your direction and it is employment, priced near 1.3 times the wage. The only decision left is whether you pay that now through payroll or later through IRC 3509, a premium audit and a state assessment.
Most growing trades businesses end up with both, because most have both kinds of work. Get the labels to match the reality and the rest is arithmetic. If you are reaching for the cheaper label because the work is too unpredictable to promise anyone a full week, fix that first. No classification strategy survives an empty schedule.