Why Calling Your Employee a "Contractor" Could Cost You Thousands

WINTER 2026.- I get it. Hiring someone as a 1099 independent contractor instead of a W-2 employee seems like the smart move. You save on payroll taxes, workers' comp insurance, health benefits, and overtime. It's cleaner, simpler, and cheaper.

Except when it's not.

Last month, I sat across from a small business owner who'd just received a letter from the Illinois Department of Employment Security. His "contractors" had filed for unemployment benefits, triggering an audit. The result? Over $75,000 in back taxes, penalties, and interest. His business barely survived.

Here's what kept him up at night: he genuinely thought he was doing everything right. He had signed agreements. His workers wanted to be contractors. Everyone seemed happy with the arrangement.

But none of that mattered. Because in the eyes of the law, those workers were employees all along.

The Problem: It's Not About What You Call Them

The biggest misconception I see is this: employers think they can choose whether someone is an employee or contractor.

You can't.

It doesn't matter what you write in a contract. It doesn't matter if your worker wants to be a contractor. It doesn't even matter if they have their own LLC.

What matters is the actual working relationship. The law looks at how you treat the worker, not what you call them.

The Test: How Illinois Determines Worker Classification

Illinois uses what's called the "ABC test" for unemployment insurance purposes, and it's strict. To classify someone as an independent contractor, you must prove ALL three of these:

A. They're free from your control

• They decide when, where, and how to do the work

• You don't supervise their daily activities or provide training

• They use their own methods and processes

B. The work is outside your usual business

• If you run a landscaping company, you can't hire landscapers as contractors

• The work must be different from what your business actually does

C. They have an independent business

• They market their services to other clients

• They have multiple customers

• They invested in their own equipment and tools

Here's the hard truth: if you can't prove all three, they're an employee under Illinois law.

Real-World Examples

Example 1: The "Contractor" Who's Really an Employee

Sarah owns a marketing agency. She hired Tom to write social media content. Tom works 9-5, Monday through Friday at Sarah's office. Sarah assigns him clients and tells him what to post. Tom uses Sarah's computer and only works for her agency.

Reality: Tom is an employee. Sarah controls when and how he works, the work is central to her business, and Tom doesn't have an independent business.

Example 2: An Actual Independent Contractor

Mike owns a restaurant. His ice machine breaks. He calls Jennifer, who owns "Jennifer's Commercial Appliance Repair." Jennifer comes when she's available, uses her own tools, fixes appliances for dozens of restaurants, and advertises her business online.

Reality: Jennifer is legitimately an independent contractor.

What You're Actually Liable For

When you misclassify employees as contractors in Illinois, here's what can come back to haunt you:

Back Taxes and Penalties: Unpaid Social Security, Medicare, and unemployment taxes, plus penalties that can equal 100% of unpaid taxes and interest. For a worker making $50,000 a year over three years, you could owe $25,000 or more.

Unpaid Overtime: If your "contractor" worked over 40 hours a week, you might owe two years of back overtime pay, an equal amount in liquidated damages, and their attorney's fees. That could easily exceed $50,000 for a single worker.

Workers' Compensation Violations: If your misclassified "contractor" gets injured on the job, you could face fines up to $500 per day, personal liability for their medical bills and lost wages, and even criminal penalties.

Class Action Lawsuits: One misclassified worker figures it out, finds others you've misclassified, and suddenly you're facing a class action with dozens of workers claiming back pay plus attorneys' fees. I've seen this destroy businesses.

"But They Signed a Contract!" and Other Myths

Myth 1: "We have a contract saying they're a contractor."

That contract isn't worth the paper it's printed on if the actual relationship doesn't match. Courts and agencies care about the economic reality, not what your contract says.

Myth 2: "They wanted to be contractors!"

Worker classification isn't something you can negotiate. It's determined by law based on the facts of the relationship. The law doesn't allow workers to waive their employee status, even if they want to.

How Audits Happen

Audits are triggered by:

• A worker filing for unemployment benefits

• A workplace injury

• An employee complaint to the Department of Labor

• Random selection by the IRS or state agencies

Once an audit starts, agencies look back three years, examine how you paid and controlled workers, and calculate what you owe including all back taxes, penalties (often 100% or more of taxes owed), and compounding interest.

How to Protect Yourself

1. Audit Your Current Contractors

Go through each person you classify as a contractor and honestly ask:

• Do I control when and how they work?

• Is the work they do central to my business?

• Do they work exclusively for me?

• Do they have their own business infrastructure?

If they fail the ABC test, they need to be reclassified.

2. Reclassify Workers If Needed

Move them to W-2 payroll immediately, get workers' comp coverage, and start withholding employment taxes. The Illinois Department of Employment Security offers voluntary disclosure programs that can reduce penalties if you come forward before being audited.

3. When in Doubt, Classify as Employee

The extra cost of payroll taxes and workers' comp insurance is far less than the cost of an audit, lawsuit, or penalty.

Special Considerations for Illinois Employers

Illinois is particularly aggressive about worker misclassification. The Employee Classification Act allows the Department of Labor to conduct random audits, issue stop-work orders, and impose civil penalties up to $2,500 per misclassified worker.

Illinois targets industries with high misclassification rates: construction and trades, cleaning services, delivery and logistics, home healthcare, and hospitality.

What If You've Already Misclassified Workers?

Option 1: Reclassify going forward and hope past misclassification isn't discovered. Risk: if audited, you'll still owe back taxes and penalties.

Option 2: Contact the Illinois Department of Employment Security about their voluntary disclosure program. Work with an employment attorney to minimize penalties. Penalties are often reduced significantly when you come forward voluntarily.

Option 3: Use the IRS Voluntary Classification Settlement Program (VCSP) to pay only 10% of what you would have owed in employment taxes for the most recent year.

The Bottom Line

I know hiring employees is expensive. I know the temptation to classify workers as contractors to save money.

But here's what I need you to understand: misclassification isn't a gray area you can navigate carefully. It's a ticking time bomb.

You might save 30% on labor costs by using contractors instead of employees. But when the audit comes, when the lawsuit is filed, when the penalties start piling up, you could lose your entire business.

If you're unsure about any of your worker classifications, reach out to an employment attorney. Most of us offer free consultations, and we'd rather help you get it right now than defend you in an audit later.

Your business is worth protecting. Let's make sure you're doing it the right way.

Questions about your specific worker classification situation? I offer free consultations to Illinois employers. Let's review your workforce together and make sure you're protected.