By Craig S. Cody, CPA, Certified Tax Coach.
Here's the answer up front. Whether your freelancers are contractors isn't decided by what your agreement calls them. It's decided by three readers you don't control: the IRS, the state where the freelancer sits, and the buyer's lawyer in due diligence if you ever sell. Each of them applies a test. None of them cares about the label.
What they care about is whether the way you actually work with that person matches the story, and whether you can prove it on the day they ask.
So ask yourself the question now. Are you documenting that your contractors are contractors? Written agreements, their invoices, everything buttoned up? The last thing you want is a problem during due diligence, or a notice from the IRS or the state, with no documentation at the ready. We've seen both of those, and the prepared business is the business that passes.
👉 Want to learn more? Check out our entire ultimate guide on Tax Planning for Marketing and PR Agency Owners!
My firm works with more than 70 marketing and advertising agency owners every month, and I've spent 23 years reading agency returns. Agencies run on freelancers more than almost any business I see: designers, developers, writers, editors, media buyers, fractional strategists. It's how you keep people costs flexible when a retainer ends. It's also where the most expensive surprise in the business tends to live, because the exposure runs backwards through every year you paid them.
Control. Not the contract, the control.
The IRS applies a common-law test built on three categories of evidence.
No single factor decides it. The whole picture does. And either side can ask the IRS to rule on it by filing Form SS-8, which is a decision to make with your eyes open: a worker who files one has just invited an examination of everyone in the same role.
Here's the agency version of the picture. A designer with a company email address, a seat in your Monday status meeting, a manager who assigns and reviews their work, your Slack, your project management tool, forty hours a week, and no other clients. Every one of those is an employee fact. The agreement that calls them a contractor is the only contractor fact on the table.
Something stricter, in the states that matter most.
California, New Jersey and Massachusetts, among others, apply a version of the ABC test. To be a contractor, the worker has to be free from your control, doing work outside the usual course of your business, and customarily engaged in an independent trade doing that kind of work. All three. The second prong is the one agencies fail: a freelance designer doing design work for a design agency is doing work squarely inside the usual course of your business.
Here's the part the generic articles get wrong about California. The state's law carves a list of professional services out of the ABC test and back into the older, more forgiving multi-factor test, and the list reads like an agency's contractor roster: marketing involving original and creative content, graphic design, fine art, photography and videography, freelance writing, content creation, photo editing.
The carve-out has conditions, and all of them have to hold. The freelancer maintains a business location separate from yours, which can be their home. They hold a business license or tax registration where the city requires one. They set or negotiate their own rates. They set their own hours, outside of project deadlines. Meet those and your California designer is tested the old way. Miss one and you're back under the ABC test, failing the second prong.
Don't assume other ABC states have the same door. Check the one your freelancer actually sits in, because the state that matters is theirs, not yours.
The federal wage-and-hour test is a third layer, and it's moving. The Department of Labor proposed in early 2026 to replace the 2024 rule with a five-factor economic-reality test that weights control and opportunity for profit more heavily. As I write this, it isn't final. Plan on the control facts, because they matter under every version.
Back employment taxes on every year in the window, and the rate depends on whether you filed the 1099s.
If you filed 1099s and the IRS reclassifies the worker anyway, the code gives you reduced rates: roughly 10.68% of wages up to the Social Security wage base and a little over 3% above it. If you didn't file the 1099s, those rates double. That's federal only. Add state unemployment insurance, workers' compensation premiums, penalties and interest, and in some states the wage-and-hour claims that come with employee status.
Multiply by the number of years and the number of people in the same role, because that's how the exposure works. It isn't one designer for one year. It's every designer you've treated the same way for as long as you've treated them that way.
And there's a third reader whose bill isn't a tax at all. A buyer's counsel in diligence will pull your 1099 roster, ask which of these people look like employees, and price the exposure into the deal, or hold it back in escrow. The classification question you never got a notice about becomes a line item in your sale. It's one of the decisions I walk through in my tax planning guide for marketing and PR agency owners, and it's the one most owners have never looked at through a reader's eyes.
Section 530 relief, and it's the single most important thing to understand about this whole topic, because it turns a documentation habit into a legal defense.
Under Section 530 of the 1978 Revenue Act, the IRS cannot reclassify a worker for employment tax purposes if you meet three requirements.
Read those three again, because they're the file. The written agreement establishes the basis. The 1099s establish reporting consistency. Treating every freelancer in a role the same way establishes substantive consistency. Do all three and a reclassification attempt has to get past Section 530 first. Skip any one and you're arguing the control factors on their merits, which is the argument you don't want to be having.
There's an exit, and it's a good one if you take it before anyone else notices.
The IRS runs a Voluntary Classification Settlement Program. You agree to treat a class of workers as employees going forward, and in exchange you pay roughly 10% of the employment tax that would have been due on their compensation for the most recent year, computed at the reduced rates. No interest. No penalties. No employment tax audit of those workers for prior years.
Three conditions. You must have treated them consistently as nonemployees. You must have filed the 1099s for the prior three years. And you can't already be under an employment tax examination. You apply on Form 8952 at least 120 days before the date you want the reclassification to take effect.
Notice what the program rewards. The agency that filed its 1099s. The one that didn't is doubly exposed: the rates double on examination, and the door to the settlement program is shut.
It changes the paperwork. It doesn't change the exposure.
For payments made after December 31, 2025, the threshold for issuing a 1099-NEC rose from $600 to $2,000, indexed for inflation starting in 2027. An agency that pays a dozen small freelancers a few hundred dollars each will file fewer forms for 2026.
But Section 530's reporting consistency requirement is about filing the forms that are required. For every freelancer you pay $2,000 or more, the 1099 still has to go out, still has to be on time, and still has to be there every year. Nothing about a higher threshold makes the file less important for the people who matter. It just shortens the list.
The same thing that breaks every position on this page: conduct that contradicts the paper.
Every one of those is a decision made during the year, and every one of them shows up in a bank statement, a calendar invite, or a Slack export long before it shows up in a notice.
For every freelancer you pay $2,000 or more, five things.
Then one more thing that isn't a document. A yearly look at the roster with the control questions next to each name. Who's on our email? Who's in the standing meeting? Who has a manager? Who has no other clients? Those are the humans to either convert or restructure, and doing it in a year you choose is cheaper than doing it in a year someone else does.
This is for owners of marketing, advertising and PR agencies whose delivery model runs on freelancers and who haven't looked at the roster through a reader's eyes in a while. If you have a "contractor" who's been with you three years, full time, with a company email, this is for you specifically.
It isn't for the agency whose freelancers are genuinely independent shops with their own clients, their own rates and their own tools, billed by the project. Keep the file current and you're fine.
And it isn't a substitute for employment counsel in your freelancer's state. The tests are theirs to apply. The file is yours to build.
By a common-law test built on three categories of evidence: behavioral control (how the work is done), financial control (who bears the business risk and how the worker is paid), and the relationship of the parties (written agreements, benefits, permanence, and whether the work is a key part of the business). No single factor decides it.
A safe harbor that stops the IRS from reclassifying a worker for employment tax purposes if the business filed the required 1099s every year, never treated that worker or a similar one as an employee, and had a reasonable basis for contractor treatment such as industry practice, a prior audit or a ruling.
An IRS program that lets a business reclassify a class of workers as employees going forward and pay roughly 10% of one year's employment tax at reduced rates, with no interest, no penalties and no audit of prior years for those workers. It requires consistent contractor treatment, 1099s filed for the prior three years, no current employment tax exam, and Form 8952 filed at least 120 days ahead.
Not necessarily. California carves out listed professional services, including graphic design, marketing involving original creative content, photography and freelance writing, into the older Borello test, but only if the freelancer keeps a separate business location, holds any required business license, sets their own rates, and sets their own hours. Miss one condition and the ABC test applies.
For payments made after December 31, 2025, a 1099-NEC is required only for payees paid $2,000 or more in the year, indexed from 2027. It reduces the number of forms. It doesn't change the classification tests or the Section 530 requirement to file the forms that are required.
Back employment taxes for the open years at reduced rates if 1099s were filed, roughly 10.68% of wages up to the wage base, or double that if they weren't, plus penalties and interest, and separately the state's unemployment insurance, workers' compensation and wage-and-hour consequences.
None of this is about whether freelancers are good for an agency. They are. It's about whether the way you work with them can be read by someone who isn't you, and whether the file is there when they read it.
If you want a second set of eyes on your 1099 roster before anyone else's, that's a specific conversation, and it starts with your last two returns and the list of everyone you paid. Book a Free Tax Analysis and bring both.
Filing a return isn't a tax strategy. Let's talk.
Craig S. Cody is a CPA, Certified Tax Coach, and retired NYPD Lieutenant. His firm works with more than 70 marketing and advertising agency owners every month, helping them keep more of what they make through proactive tax planning.
This article is general education, not advice for your specific situation. Confirm your own facts with your advisor before acting.