W-2 or 1099: classifying the clinicians in your practice

Almost every group practice owner faces the same decision when the second clinician joins: put the new therapist, psychologist, speech-language pathologist, or behavior analyst on payroll as a W-2 employee, or pay them as a 1099 contractor. The contractor route is correct in some arrangements. The facts of the working relationship decide it, not the label on the agreement, and the tax consequences of a wrong answer land on the practice rather than the clinician.

This post covers the tax and classification side of the decision. The bookkeeping and payroll side, meaning how each arrangement actually runs through the books every month, is covered by our affiliated bookkeeping company, bookkeepz, LLC, in its companion post on W-2 and 1099 clinicians.

The test the IRS actually applies

For federal employment tax, the question is the common-law test. IRS Publication 15-A puts the core of it plainly: anyone who performs services for you is generally your employee if you have the right to control what will be done and how it will be done. The word that matters is right. The key consideration, in the publication’s words, is whether the business has retained the right to control the details of a worker’s performance or has instead given up that right. A practice that could direct how an associate works has that right whether or not it ever uses it.

The IRS organizes the evidence into three categories. Behavioral control asks whether the practice controls, or has the right to control, what the clinician does and how. Financial control asks whether the business aspects of the clinician’s job are controlled by the practice. The type of relationship asks whether the arrangement is expected to continue and whether the work is a key aspect of the business. For a therapy practice, seeing clients is the business itself.

Two common beliefs do not survive the IRS’s own pages. The first is that there is a checklist of twenty factors and a score that settles the question. The IRS says there is no magic or set number of factors that makes a worker an employee or a contractor. The second is that a licensed professional is a contractor by nature. Publication 15-A does say that doctors, veterinarians, and others who offer their services to the public in an independent profession are generally not employees, and then adds that it depends on the facts in each case. A licensed clinician who sees only the practice’s clients, on the practice’s schedule, under the practice’s name, is hard to describe as offering services to the public.

When the answer is genuinely unclear, either the practice or the clinician can file Form SS-8 and ask the IRS for a determination. The IRS notes that a determination may take at least six months, so it is rarely a tool for a hiring decision that needs to be made this month.

The two choices side by side

What each choice costs

On a W-2 clinician, the practice pays the employer half of Social Security and Medicare: 6.2 percent for Social Security on wages up to the 2026 wage base of $184,500, and 1.45 percent for Medicare with no wage cap, matching what it withholds from the clinician. It owes federal unemployment tax at 6.0 percent on the first $7,000 of each employee’s wages, which falls to 0.6 percent for a practice entitled to the full 5.4 percent credit for state unemployment tax. State unemployment tax and workers’ compensation come on top, and both are governed by state law. In North Carolina, workers’ compensation applies to a business in which three or more employees are regularly employed.

On a 1099 clinician, the practice pays none of that. The clinician pays self-employment tax instead on 92.35 percent of net earnings from self-employment, once those earnings reach $400. The Social Security part is 12.4 percent and applies only up to the wage base, $184,500 for 2026. The Medicare part is 2.9 percent. The clinician deducts half of the tax on the personal return. The clinician also handles their own income tax, since the practice withholds nothing from a contractor.

The payroll tax a practice avoids by using contractors has to be weighed against the cost of a reclassification, which is what the rest of this post covers.

The paperwork changed for 2026

For payments made after 2025, the One Big Beautiful Bill Act (Public Law 119-21) raised the Form 1099-NEC reporting threshold from $600 to $2,000 for a calendar year, and the IRS instructions say it may be adjusted for inflation beginning in calendar year 2027. The change is not retroactive: payments made in 2025 were reported under the $600 threshold. Form 1099-NEC is due by January 31, both to the IRS and to the clinician, or the next business day when January 31 falls on a weekend. For 2026 payments that makes it Monday, February 1, 2027.

Many clinicians contract through their own entity, such as a professional corporation, or an LLC or PLLC taxed as an S or C corporation. Payments to a corporation are usually exempt from 1099 reporting, but the IRS instructions say that exemption does not apply to payments for medical or health care services provided by corporations, including professional corporations. Box 6 of Form 1099-MISC, medical and health care payments, covers payments of $2,000 or more made in the course of a trade or business to each provider of medical or health care services, and the instructions say to list the corporation as the recipient when the payment is made to one. A W-9 showing that a clinician’s entity is a corporation does not, by itself, end the 1099 question for health care payments.

Neither form decides whether the clinician is an employee. As the next section shows, filing the forms you are required to file is what keeps several of the relief options open.

What happens if the IRS reclassifies a clinician

A practice that treated an employee as a contractor is generally liable for the Social Security and Medicare tax and the income tax it should have withheld. Section 3509 of the Internal Revenue Code softens that for a practice that did not intentionally disregard the rules: the income tax portion is figured at 1.5 percent of wages, and the employee share of Social Security and Medicare at 20 percent of the normal amount. Publication 15 translates that into effective rates of 7.44 percent of wages for Social Security, 1.74 percent for Medicare, and 1.5 percent for income tax withholding. Added together, by our computation from Publication 15’s rates, that is roughly 10.7 percent of the wages up to the Social Security wage base, before any Additional Medicare Tax.

Those rates assume the practice filed the 1099s. When it did not, and the failure was not due to reasonable cause, section 3509(b) doubles the reduced figures to 3 percent and 40 percent, which Publication 15 states as 8.68 percent for Social Security, 2.03 percent for Medicare, and 3.0 percent for income tax withholding, or about 13.7 percent of the wages up to the Social Security wage base by our computation from those rates. Section 3509 is not available at all for intentional disregard, and a practice that pays under it cannot recover the employee share from the clinician afterward.

Once clinicians are on payroll, the income tax and the employee share of Social Security and Medicare withheld from their pay are trust fund taxes: the practice holds them for the government. If those taxes are not withheld, or not deposited or paid, the trust fund recovery penalty may apply. The penalty is 100 percent of the unpaid trust fund tax, and when the practice itself cannot pay, Publication 15 says it may be imposed on the persons the IRS determines were responsible for collecting, accounting for, or paying over the taxes and who acted willfully in not doing so.

Section 530 relief and the VCSP

Section 530 relief from worker reclassification is available when three requirements are met. The practice must have timely filed the required information returns, meaning the 1099s, consistent with treating the worker as a non-employee. It must not have treated the worker, or anyone in a substantially similar position, as an employee at any time after December 31, 1977. And it must have had a reasonable basis for contractor treatment, which the IRS says can include judicial precedent, a prior audit, or a long-standing recognized practice of a significant segment of the industry.

The consistency requirement matters in a group practice that pays some associates on W-2 and others on 1099 for substantially the same clinical work. Under the rule as the IRS states it, that mix can put section 530 out of reach.

A practice that has been paying clinicians as contractors and wants to move them to payroll prospectively can apply to the Voluntary Classification Settlement Program. To qualify, it must have consistently treated those workers as contractors, must have filed all required 1099s for them for the previous three years (1099s filed within six months of their due date still count), cannot currently be under employment tax audit by the IRS, and cannot currently be under audit concerning the classification of the workers by the Department of Labor or a state agency. The payment is 10 percent of the employment tax liability for the most recent tax year, computed at the reduced section 3509(a) rates, with no interest or penalties on that amount. In return, the practice will not be subject to an employment tax audit on the worker classification of the reclassified workers for prior years. The IRS puts the section 3509(a) rate at generally 10.68 percent of compensation up to the Social Security wage base, so by our computation the payment works out to roughly 1.07 percent of that compensation for the most recent year. The application, Form 8952, should be filed at least 120 days before the date the practice wants to start treating the clinicians as employees.

The Department of Labor asks a different question

Wage and hour law under the Fair Labor Standards Act uses an economic reality test, which asks whether the worker is economically dependent on the business or in business for themselves, and the Department of Labor says that relationship is not determined by common-law standards of control. A clinician can be analyzed differently under the two. The DOL has also said that whether a contractor holds a state or local license has no bearing on whether there is an employment relationship under the FLSA.

The DOL’s own rule is in flux, and it is worth knowing exactly where. Its 2024 rule took effect on March 11, 2024. On May 1, 2025, the Wage and Hour Division announced it would stop applying that rule in its own investigations and would use Fact Sheet #13 (July 2008) and Opinion Letter FLSA2019-6 instead, while stating that the 2024 rule remains in effect for purposes of private litigation. On February 27, 2026, the DOL published a proposal to rescind the 2024 rule and return to its January 2021 rule with modifications, treating control over the work and the opportunity for profit or loss as the two most probative factors. The comment period closed on April 28, 2026. As of this post, no final rule has been published.

State law can be stricter than federal law

North Carolina, where this firm is based, follows the federal approach for the two state tax regimes that matter most here. Its unemployment insurance law defines an employee by reference to the federal unemployment tax definition, which in turn points to the common-law test, and its income tax withholding rules define wages by reference to the federal definition. North Carolina does not apply an ABC test for either.

California does. Under Labor Code section 2775, a worker is an employee unless all three prongs are met: the worker is free from the practice’s control and direction both under the contract and in fact, the work is outside the usual course of the practice’s business, and the worker is customarily engaged in an independently established business of the same kind. A therapist who sees clients for a therapy practice has trouble with the second prong on its face. Labor Code section 2783(b), in its current text as amended by AB 1514 effective January 1, 2026, sends physicians and surgeons, dentists, podiatrists, psychologists, and veterinarians licensed by California who perform professional or medical services provided to or by a health care entity to the test from Borello instead, a 1989 California Supreme Court decision that applies a multi-factor test centered on control. Marriage and family therapists, clinical social workers, speech-language pathologists, physical and occupational therapists, and behavior analysts are not on that list, so the ABC test is the default for them.

For pre-licensed behavioral health clinicians in California, licensing law answers the question before any ABC or common-law test is reached. Business and Professions Code section 4980.43.3(a) says a marriage and family therapy trainee, associate, or applicant for licensure shall only perform mental health and related services as an employee or volunteer, and not as an independent contractor, and an employed associate must give the board copies of the W-2 forms for each year of experience claimed when applying for licensure. The section was most recently amended by SB 775, effective January 1, 2026. Sections 4996.23.2(a) and 4999.46.3(a) say the same for associate clinical social workers and for clinical counselor trainees and associates.

Massachusetts applies an ABC test under its wage laws with the same three-part shape. New Jersey adopted regulations on May 5, 2026 clarifying its ABC test for unemployment, wage and hour, and wage payment law, and they become operative on October 1, 2026. New Jersey’s second prong can be met if the work is outside the usual course of the business or is performed outside all of the business’s places of business. A practice with clinicians in more than one state has to answer the question state by state, which is part of the multi-state work we do and is touched on in our post on remote work.

The qualified business income deduction

Classification also changes the clinician’s own return. Income earned as an employee is never eligible for the qualified business income deduction under section 199A. A contractor’s practice income can be, although a health practice is a specified service trade or business, a category the IRS defines to include services in the field of health, so the deduction phases out as the clinician’s taxable income rises. For tax years beginning after 2025 there is also a new minimum deduction for qualified business income from an active trade or business, which sets a floor under the deduction.

That creates an incentive to convert employees into contractors, and the regulations anticipate it. Under Treasury Regulation section 1.199A-5(d)(3), a clinician who was properly treated as an employee and is then treated as a contractor by the same practice for substantially the same services is presumed, for three years, to still be performing services as an employee for purposes of the deduction. The clinician can rebut the presumption by showing that, under federal tax law and the common-law rules, they are performing services in a capacity other than as an employee. Moving an associate from W-2 to 1099 for the same work does not, on its own, create a deduction.

Associates and pre-licensed clinicians

Practices with associates working toward full licensure ask whether billing and supervision rules force a particular classification. Medicare’s incident-to rules let services furnished by supervised staff be billed by the supervising practitioner, and they do not require W-2 status. The regulation at 42 CFR 410.26 defines auxiliary personnel as anyone acting under the supervision of a physician or other practitioner, regardless of whether that person is an employee, a leased employee, or an independent contractor. Behavioral health services can be furnished incident-to under general supervision, which the regulation defines as the practitioner’s overall direction and control without the practitioner’s presence being required during the service. Only the supervising practitioner may bill Medicare for them. State licensing law can be stricter than Medicare: in California, associate marriage and family therapists, associate clinical social workers, and associate professional clinical counselors may only provide services as employees or volunteers, never as independent contractors, under the Business and Professions Code sections described above.

Licensing boards set their own supervision expectations. The North Carolina Social Work Certification and Licensure Board’s position statement on clinical supervision, as amended May 2026, makes the clinical supervisor responsible for oversight and guidance of an associate’s treatment, diagnosis, treatment planning, documentation, and related clinical work, and says the Board strongly discourages independent private practice by LCSW associates and will closely examine practice outside a public agency or established organization.

We have not found IRS or Department of Labor guidance that says whether supervision a licensing board requires counts as control for classification purposes, in either direction. It is one fact among many in the analysis, and it should be weighed on the facts of the particular arrangement rather than assumed to settle it.

How the decision usually comes out

A clinician who sees the practice’s clients, under the practice’s name, on a schedule and with paperwork the practice sets, looks like an employee under the common-law test and has trouble with the usual-course prong of an ABC test. A clinician who runs their own practice, carries their own clients and insurance, sets their own methods, and contracts with several organizations looks like a contractor. When an associate fits the first description, the facts point to payroll, and the employer taxes are the cost of that arrangement rather than an optional expense.

Where we help

We review how a practice’s clinicians are actually engaged against the federal test and the rules of each state where they work, and we prepare the Form 8952 filing when a move to payroll through the VCSP is the right answer. For practices taxed as S corporations, the associates’ pay also feeds the owner’s own number, since what the practice pays W-2 clinicians for comparable clinical work is evidence for the owner’s reasonable salary. The general standard is in our post on reasonable compensation, and the entity side is on our S corporation page.

Our pages for therapy practices, psychologists, speech-language pathologists, physical therapists, ABA practices, dentists, and veterinarians cover what is different about each. If you are adding clinicians, or already have associates on 1099 and are unsure the arrangement holds, book a consultation and we will look at the facts with you.

This post covers federal tax rules and selected state rules as general information. It is not legal advice, and state employment law varies, so an employment attorney should review contracts and state-law questions for your practice.

• Worker classification
• Group practice
• Payroll tax