Worker classification
1099 vs. W-2 for Construction Workers
How to tell a real subcontractor from an employee, what Arizona is doing about misclassification in 2026, and how to work with subs safely.
Paying crew members on a 1099 saves payroll taxes and workers' comp on paper. But if those workers are really employees, the savings turn into back taxes, back overtime, penalties, and comp premium at audit. Arizona is paying closer attention in 2026, and construction is the industry it's watching most.
The quick test
A worker is probably your employee if you:
- Set their schedule and tell them how to do the work
- Supply the tools, materials, and truck
- Pay by the hour or day rather than by the job
- Have them work only for you, week after week, as part of your regular crew
A real subcontractor runs their own business: bids the job, controls how it gets done, brings their own tools and people, can make or lose money on it, carries their own insurance and contractor's license, and works for other customers too.
The tests the agencies use
- IRS (payroll taxes): the common-law test, which looks at behavioral control, financial control, and the relationship between the parties.
- U.S. Department of Labor (minimum wage and overtime): an "economic reality" test asking whether the worker is in business for themselves or economically dependent on you. The Department stopped enforcing its 2024 rule and in February 2026 proposed returning to a test where control over the work and the opportunity for profit or loss carry the most weight. Check the Department's site for the current status.
- Arizona: state agencies apply their own rules for unemployment insurance, income tax withholding, and workers' comp. A signed Declaration of Independent Business Status under A.R.S. § 23-1601 can support contractor status under state law, but it doesn't settle federal tax or wage questions, and it won't hold up if the actual working relationship looks like employment.
Arizona's 2026 crackdown
On May 20, 2026, Governor Hobbs signed Executive Order 2026-01, directing the Department of Economic Security, the Department of Revenue, the Industrial Commission, and the Registrar of Contractors to share evidence and jointly enforce worker classification laws. The order singles out construction, estimating that about 13 percent of Arizona construction workers, more than 30,000 people, are misclassified. In practice, a problem found in one place, such as an unemployment claim or a workers' comp audit, is more likely to reach the others.
What misclassification costs
- Both halves of Social Security and Medicare, plus federal and state unemployment tax, with interest and penalties
- Back overtime for hours over 40, and federal liquidated damages equal to the back pay
- Workers' comp premium on the reclassified payroll at audit, and exposure if one of those workers is hurt
- Unemployment claims charged to your account when the work ends
Working with real subs the right way
- A written subcontract for each job, with scope and price
- An Arizona Registrar of Contractors license for the work they do, if one is required
- A current certificate of insurance for workers' comp and general liability before they start. Under Arizona's statutory employer rule, an uninsured sub's workers can be treated as yours for a comp claim. More on subs and workers' comp.
- A Form W-9 on file, and a Form 1099-NEC by January 31 for each sub you paid $2,000 or more during 2026. The threshold was $600 through 2025 and is indexed for inflation starting in 2027.
If your "subs" are really crew
Moving workers onto payroll is usually cheaper than defending the classification later. A PEO makes the switch simpler: it runs payroll and payroll taxes, covers the crew under its workers' comp policy, and handles new-hire paperwork, for a flat administrative fee instead of a stack of new vendors. See how PEO pricing works.
1099 vs. W-2 questions
Can I pay my crew on a 1099 in Arizona?
Only if they're truly independent businesses: they control how the work is done, bring their own tools and people, can make or lose money on the job, and work for others. Workers you schedule, supervise, and equip are usually employees, whatever the paperwork says.
Does Arizona's Declaration of Independent Business Status make someone a contractor?
It can support contractor status under Arizona law, but it doesn't settle federal tax or wage questions, and it won't hold up if the actual working relationship looks like employment.
What is the 1099-NEC threshold for 2026?
$2,000. For payments made in 2026, you file a Form 1099-NEC for each nonemployee you paid $2,000 or more, up from $600 through 2025. The threshold is indexed for inflation starting in 2027.
Is Arizona enforcing worker misclassification in construction?
Yes. Executive Order 2026-01, signed May 20, 2026, directs four state agencies, including the Registrar of Contractors and the Industrial Commission, to share evidence and jointly enforce classification laws, with construction singled out.
Moving crew onto payroll?
A PEO through PayMyCrew runs payroll, files payroll taxes, and handles the reporting, for a flat $75 per employee per month in Arizona (subject to provider approval); a national provider covers other states. Free quote, no obligation. Use the quote form