How to Pay 1099 Workers Legally in California: What Every LLC and Small Business Owner Must Do in 2025
Every California LLC owner knows the fear: one audit, one employee misclassification, and you could face tens of thousands in fines from the IRS or state. The rules for paying 1099 workers legally in California aren’t just technical—they’re traps that cost unprepared business owners real money every year.
The myth? Any business can simply issue a 1099 to a contractor and call it compliant. The reality: California law (especially AB5) and IRS guidelines demand far more. If you get this wrong, you risk reclassification, back payroll taxes, penalties, and worse—potential criminal liability.
Quick Answer
The only way to pay independent contractors legally in California is to ensure each worker meets both state and IRS tests for 1099 status (not an employee), use proper contracts, collect and file Form W-9, issue Form 1099-NEC for payments of $600 or more, and keep airtight records. For 2025, California’s rules (including AB5) are stricter than federal.
When explaining how to pay 1099 workers legally in California, remember that “legal payment” starts with legal classification. The IRS looks at behavioral and financial control—who directs the work, who provides tools, and how payment is structured. California’s AB5 law goes further: even a valid federal 1099 can be reclassified under the ABC test if the worker performs core business tasks. The safest approach is to verify both federal and state tests before the first dollar is paid.
Who Counts as a 1099 Worker in California?
Before you pay a freelancer as a 1099, you must know who actually qualifies. The IRS uses the ‘Common Law Test’—behavioral control, financial control, and relationship type. California adds the ABC test:
- A: The worker is free from your direction/control
- B: They perform work outside your usual business
- C: They customarily do this work as an independent business
If your web developer, for example, works from their own business, controls their schedule, and invoices others, they’re likely a valid 1099. If you have a bookkeeper who works on-site, full time, only for you—they likely fail the test. Misclassification triggers both IRS and California EDD audits. See IRS definition of independent contractor; for local enforcement, review California’s ABC Test explanations.
LLC and Small Business Owner Compliance: Step-by-Step Guide
To pay 1099 contractors legally, every LLC and business must:
- Get a signed W-9 form before the first payment (official IRS W-9).
- Draft (and keep) a clear contractor agreement outlining job, payment, and independence. Include project scope, timeline, and that contractor provides their own tools.
- Only pay by business check, bank ACH, or business credit card—never cash. Always reference invoice # and work completed.
- Issue a 1099-NEC form by January 31 of the following year for all contractors paid $600+ (see IRS Form 1099-NEC rules).
- Keep three years of payroll records, agreements, invoices, and communications in case of audit.
Miss any of these steps? You open the door to both California and federal payroll tax assessments and fines up to $25,000 per worker plus retroactive unemployment tax, Social Security, and penalties.
What Makes California So Strict? Delta Between IRS and State Law
California’s AB5 law crushed the old ‘gig economy’ gray area in 2020—now, almost every worker must pass the ABC test. Even if the IRS lets you issue a 1099, California can (and does) reclassify many as employees. That means:
- Construction, trucking, beauty, and hospitality are top audit targets
- Penalties can reach $10,000–$56,000 per misclassified worker, especially if the California Employment Development Department (EDD) decides you misclassified intentionally
- Industries like tech and consulting must prove contractors operate true independent businesses
One audit trigger: paying the same 1099 for more than $15,000/year or as their only client. KDA regularly sees EDD desk audits triggered from a single worker complaint or routine 1099 filing.
KDA Case Study: LLC Owner Wins Audit With Proactive 1099 Compliance
Case study: “Jenny owns a marketing agency LLC in Los Angeles. She contracts 5 copywriters, paying $98,000 total per year—each sent a 1099. In 2024, Jenny receives an EDD audit notice, questioning whether her writers are employees.
KDA’s team quickly reviewed Jenny’s contractor records: Each copywriter signed a detailed independent contractor agreement up front. Jenny kept all W-9s, copies of outgoing 1099s, and matching invoices from writers using their own business entities. Each freelancer had multiple clients—demonstrated via their own websites and references. KDA assembled a clear file for EDD, highlighting compliance with both IRS and California’s ABC test.
Result: EDD completed a no-change audit. Jenny’s risk? Without these protocols, her misclassification penalty would have been $42,100 for three workers. After KDA’s help, her cost: $0. She invested $3,600 in annual compliance services—her ROI was over 11x her spend in avoided penalties.
Ready to see how we can help you? Explore more success stories on our case studies page to discover proven strategies that have saved our clients thousands in taxes.
What Forms Must I File? Avoiding IRS and EDD Red Flags
Every payment to a contractor (over $600/year) must be documented on a 1099-NEC. Each worker fills a W-9. Send copies of the 1099-NEC to both the IRS and the contractor and file with California EDD if required. Miss this, and penalties can exceed $280 per form federally—plus separate state fines. Electronic filing is now mandatory for businesses producing 10+ 1099s. Always double-check TINs using the IRS TIN Matching system.
Pro Tip: Never cut checks payable to “cash”—always to a business name or the contractor’s full name matching their W-9.
Why Most LLCs Get 1099 Payments Wrong—And How to Avoid the Trap
The most common mistake: treating long-term, core-scope workers as 1099s. If you direct someone’s hours, supply their workspace or tools, or they work only for you—they’re an employee by federal and state law (even without a written employment contract). The IRS and California can look past paperwork to real-life behavior.
- Red Flag: “Your 1099 must supply their own equipment, have multiple clients, and invoice you, not just get paid like payroll.”
- Red Flag: Avoid 1099 arrangements with roles central to your business mission (e.g., front desk, permanent support roles)
- Red Flag: Don’t pay 1099s via payroll platforms like Gusto/ADP—use bill.com, QuickBooks contractor feature, or business ACH/wire
Skip HR apps that treat all workers the same—California compliance requires contractor-specific systems.
Implementation Guide: Setting Up 1099 Payments for the First Time
Here’s a practical checklist for any California LLC or business owner:
- Draft and sign an independent contractor agreement covering all scope, payment, and independence points.
- Collect W-9 forms and verify TINs before any payment. Save digital and paper copies.
- Request and keep invoices for each service/project with clear business purpose.
- Issue payments from your business account only. Reference the job or invoice in memo fields.
- Log all payments in your accounting software (QuickBooks, Xero). Set a recurring review to catch missing documents monthly.
- In January, create and send Form 1099-NEC to every applicable contractor and the IRS. For more than 10 forms, mandatory e-file applies in 2025 (see IRS e-file options).
- Stay current on AB5 and EDD laws—California shifts coverage frequently.
If you’re unsure, request IRS or FTB reviews via SS-8 status or seek a private letter ruling. Missteps are often the result of reliance on generic payroll advice—get strategy tailored to California law every year.
Determining Contractor vs Employee: Myths, Risks, and the Audit Reality
Myth: If your worker asks to be paid as a 1099, you’re covered. Fact: The business determines legal status, not personal preference. Many misclassify out of convenience, often leading to an audit. In 2023, EDD and IRS jointly pursued over 17,000 CA misclassification cases, resulting in over $225 million in combined penalties and back taxes.
What If the IRS or EDD Says I’m Wrong?
If either agency reclassifies your worker, retroactive payroll taxes, FICA, unemployment, and penalties are due—often for three years. Even “innocent” mistakes are rarely excused if you lack written agreements or proof the contractor operates as a distinct business. Fines can easily exceed $12,000 per worker, even for part-timers.
How Can I Prove My 1099 is Compliant?
Your best evidence: clear contracts, multiple clients, business insurance or registration, invoices, tax ID, business website, and history of project-based work. Each mitigates audit risk. For recurring 1099 staff, obtain new agreements annually.
FAQ: California 1099 Worker Compliance in 2025
Q: Can I pay a contractor with cash?
Not recommended. Always use traceable methods—ACH, check, or business card. Cash payments are audit triggers.
Q: Do I need to issue a 1099 if they’re incorporated (LLC or S Corp)?
No, except for attorneys and medical providers. See IRS rules.
Q: What if I only hired someone once for $300?
No 1099 is needed unless you paid $600 or more that year. Still, keep the W-9 and invoice on file for your records.
Q: What about remote contractors outside California?
You typically follow their home state’s law—California only for work performed within state lines or for CA-based entities.
Q: Is there an annual limit for 1099s before I must convert to employee?
No fixed limit—status is based on facts, not dollars. But high-value, ongoing work is always high-risk.
Q: Will this advice apply in future years?
This guidance is current as of 10/14/2025. Tax laws change—always verify if reading later.
Can Software Do This for Me?
Payroll software like Gusto or QuickBooks Online can help with payments and filings, but they don’t determine legal status. Only strict documentation and regular review keeps you compliant. Annual reviews with a California-focused advisor like KDA prevent six-figure mistakes.
More IRS and State Documentation for Reference
This information is current as of 10/14/2025. Tax laws change frequently. Verify updates with the IRS or FTB if reading this later.
Book Your Audit-Proof 1099 Compliance Review
Do you know if your 1099s can stand up to an audit? Avoid a five-figure penalty and get confidence your workers are classified the right way. Book your personalized compliance review—including documentation, contracts, and payment review—with a California tax strategist at KDA. Click here to book now and protect your business.
