Price the contractor roster before you inherit it.

A target’s 1099 roster is a priced item, not a footnote. Pull three years of contractor payments, test each role against the federal common-law control test, the wage-and-hour economic reality test, and the stricter state statutes, then convert the gap into back taxes, overtime, premium, and benefits. Price it or escrow it before closing.

Which documents prove how a target’s 1099 workers are actually supervised?

Proof of supervision lives in the operating records, not in the contractor agreements. Pull three years of 1099 detail, the outside-labor ledger accounts, every signed contractor agreement, certificates of insurance, W-9s, the workers’ compensation premium audits, and the dispatch logs that show who decides when each person works.

Ask in writing, by document name:

• Every Form 1099-NEC and 1099-MISC for three calendar years plus year to date, with payee names and amounts, and ledger detail for every account used to pay people off payroll.
• Every written contractor agreement, and a direct answer for each person who has none.
• Certificates of insurance, licenses, and entity names for any contractor who claims to run a business, plus the last three workers’ compensation premium audits and class worksheets.
• Any agency notice or determination on worker status, any IRS Form SS-8 determination, and the plan documents that define benefit eligibility by employee status.

I read the 1099 ledger and the dispatch schedule before the contractor agreements, because the ledger and the schedule show who is actually full time and the agreements only show what someone wanted to call them.

A person paid about the same amount every month, for years, doing the core work of the business on a schedule somebody else sets, is an employee wearing a 1099. Priced as one.

Which worker classification tests will apply to the business after closing?

Three tests apply to the same roster, and they do not agree. Federal employment tax uses the common-law right-to-control analysis. Federal wage-and-hour law uses an economic reality analysis. Several states apply statutory tests, including California’s ABC test, that presume employee status and put the burden on the business.

The federal tax test asks whether the business has the right to control what is done and how it is done. Parallel regulations state that rule for FICA, income tax withholding, and federal unemployment tax, and a long-standing revenue ruling collects twenty factors applying it, no one controlling.

Law: 26 C.F.R. 31.3121(d)-1(c); 31.3401(c)-1; 31.3306(i)-1; Rev. Rul. 87-41.

Wage-and-hour law asks whether the worker is economically dependent on the business or genuinely in business for themselves. On May 1, 2025, the Wage and Hour Division said in Field Assistance Bulletin No. 2025-1 that investigators would stop applying the 2024 independent contractor rule, and on February 26, 2026 the Department proposed rescinding that regulation. A bulletin directs investigators; a proposed rule is not law. Until a final rescission issues, the 2024 rule stays on the books, and neither document binds a court in a private overtime suit.

Law: Field Assistance Bulletin No. 2025-1 (May 1, 2025); DOL proposed rule published February 26, 2026. Stated as of October 2026; confirm whether a final rule has issued.

State law is where a defensible federal position goes to die. California presumes that a person paid for labor is an employee unless the hiring entity proves all three ABC conditions, with listed exemptions that, if established, return the relationship to the older Borello standard. Read the statute of the state where the work is performed.

Law: Cal. Lab. Code 2775; exemptions at 2776-2784; 2785(d).

One roster, three tests, three possible answers. You price the strictest one that applies to you.

How do you size misclassification exposure in dollars before closing?

Misclassification exposure has six buckets: back federal employment taxes, penalties and interest, unpaid overtime with liquidated damages, state unemployment contributions, workers’ compensation premium on unreported payroll, and benefit-plan claims from workers who would have been eligible. Each bucket has its own lookback and rate.

Where the failure was not intentional disregard of the withholding requirement and the required Forms 1099 were filed, the statute sets reduced employee-side amounts: 1.5 percent of wages for income tax withholding and 20 percent of the employee FICA share. Unfiled information returns double those to 3 percent and 40 percent. The reduction reaches employee-side numbers only, not the employer’s own share, interest, or information-return penalties. It is unavailable where the disregard was intentional, and the IRS applies it on assessment; you do not elect it.

Law: 26 U.S.C. 3509, including 3509(c).

Overtime has a clock, and it runs backward from the date suit is filed, not from closing. Claims reach back two years from filing, three if willful, each underpaid payday its own violation, and an opt-in plaintiff’s clock generally stops only on written consent. The statute adds an equal amount as liquidated damages, but a court may deny or reduce that amount if the employer proves good faith. State wage law may reach back further.

Law: 29 U.S.C. 255(a); 256; 216(b); 260.

Build a low case and a high case. Low assumes defensible roles, filed 1099s, reduced rates. High assumes a state ABC test, a three-year lookback, undiscounted liquidated damages. The spread is what you are negotiating.

Does an asset purchase leave the misclassification liability with the seller?

An asset purchase is a better starting position than an equity purchase, not a finish line. In an equity purchase you buy the entity, its employer identification number, and its filing history, so the unpaid tax rides along with the company you now own. In an asset purchase the seller’s entity generally keeps its returns and assessments.

Four things cut the other way:

• Successor liability for state tax and wage claims is state law and varies by claim. Many states require a clearance certificate or let an agency reach the purchase price, and de facto merger and mere continuation doctrines can attach to a buyer who keeps the same name, crew, and customers.
• Federal courts apply their own successor liability test under the FLSA, weighing continuity of workforce and operations. Your deal structure does not decide it.
• Wage-and-hour claims are brought by people, not by the seller. A worker who sues after closing names the business he worked for, and you answer the complaint even if you shift the cost.
• The biggest exposure is not inherited. Keep the same crew on the same 1099 terms, and every day after closing is your own liability, uncapped by any indemnity.

Unemployment experience rating is separate again. State statute decides whether the seller’s rate transfers to you, and in many states transfer is mandatory where there is substantial continuity. Ask the agency what rate you get.

The past is negotiable. The payroll you run on Monday morning is entirely yours.

Can a buyer rely on the seller’s Section 530 safe harbor?

Section 530 of the Revenue Act of 1978 is relief for a specific taxpayer in a specific federal employment tax dispute. Whether the seller qualifies is a fact question about the seller’s own history. Relief requires reporting consistency, substantive consistency, and a reasonable basis for treating the workers as non-employees. Section 530 is not part of the Internal Revenue Code.

Reporting consistency means the required Forms 1099 were actually filed, for those workers, on time. Substantive consistency means no worker in a substantially similar position was treated as an employee. Reasonable basis means something real: judicial precedent or published rulings, a prior IRS audit, or a long-standing practice of a significant segment of the industry. An express carve-out excludes certain technical service workers, including engineers, programmers, and systems analysts, supplied to a client under a three-party arrangement.

Law: Section 530, Revenue Act of 1978, including 530(d); Rev. Proc. 2025-10 (modifying and superseding Rev. Proc. 85-18); Rev. Rul. 2025-3.

Three consequences. Do not price the deal as though the relief comes with the goodwill; ask whether the 1099s were filed, every year, for every person, and get the proof. In an asset purchase you are a new taxpayer with no history, so the reasonable basis has to be yours. And Section 530 answers a federal employment tax controversy only, not an overtime claim, a state ABC test, or a premium audit.

What does reclassifying the roster cost, and how should it change the price?

Reclassifying contractors as employees on day one is the clean answer, and the cost is computable before closing. Take the annual 1099 spend for roles that fail the tests. Add employer payroll taxes at statutory rates, workers’ compensation premium at the class rate, state unemployment contributions, benefits for anyone newly eligible, and payroll administration.

That total is a percentage uplift on real money. Run it with your own inputs and your own deal’s multiple. If a fifteen percent uplift lands on a roster costing four hundred thousand dollars a year, recurring earnings fall by sixty thousand. At a four times multiple, used here only for the arithmetic, that is two hundred and forty thousand dollars of value. The roster does not just create a liability. It moves the multiple.

Some contractors will not accept W-2 terms, or will want a raise to cover the self-employment tax they were absorbing, so treat retention as a cost. Your lender sizes debt service coverage off historical cash flow with documented adjustments, and no one can tell you in advance how a credit officer will treat a payroll correction. Raise it early, in writing.

Stated as of October 2026, the operative SBA origination guidance is SOP 50 10 8.1 with Technical Policy Updates, effective October 1, 2026, announced by SBA Information Notice 5000-882227 and superseding SOP 50 10 8 of June 1, 2025. The version in force when your application is assigned an SBA loan number governs. The SOP is revised often, so confirm the current version and your lender’s credit policy rather than treating any SOP statement, including this one, as permanent.

Source: SBA, SOP 50 10 8.1 with Technical Policy Updates (eff. Oct. 1, 2026); SBA Information Notice 5000-882227 (Sept. 25, 2026).

Should the exposure go into an indemnity, an escrow, or the purchase price?

Placement depends on the size of the computed number and on how collectible the seller will be two years from now. A special indemnity assigns the risk. An escrow funds it. A price reduction removes the collection problem, though not the underlying claim. A seller’s promise is the weakest of the three.

Know what backs each one at this size. Representation and warranty insurance is a larger-deal tool, rarely available for an owner-operated acquisition, so the indemnity is worth only the escrow and seller note behind it. Cash you never pay beats cash you hold, and cash you hold beats a promise. Small number, a special indemnity is proportionate. Large number, ask for the price.

What should you ask for on your next diligence call?

The next call should produce documents, not reassurance. Request the three-year 1099 detail, the outside-labor ledger accounts, every contractor agreement, the last three workers’ compensation premium audits, and any agency notice about worker status. Set a delivery date and tell the broker the classification review is a condition of continuing.

Then:

• Have your accountant build the low and high cases from the 1099 totals, and have counsel apply the test of the state where the work is performed, role by role.
• Compute the day-one payroll uplift, rerun the earnings you are paying a multiple on, and send the revised assumption to your lender before the commitment is final.
• Decide placement, and negotiate escrow release against the lookbacks you identified.
• Prepare the offer letters, pay rates, and start date so the corrected roster can go live the first business day after closing.

I ask for the workers’ compensation premium audits before I ask the seller how the crew is paid, because the carrier already counted the people the seller is about to describe differently.