Worker Classification & Common Misinformation That Could Cost You
If you own a psychotherapy or counseling practice, you’ve probably heard this advice: “Just hire therapists as 1099 contractors. It’s cheaper and you have less liability.” Maybe a therapist has approached you asking to be hired as a 1099 because they believe they’ll get a higher fee split and save on taxes.
This common misunderstanding can be expensive. Misclassifying an employee as an independent contractor can trigger significant IRS penalties, back taxes, and legal liability.
Most associate therapists in group practices cannot legally be classified as 1099 independent contractors, regardless of what you call them in your agreement or how much they prefer that arrangement.
Misclassification Exposure: Understanding the Legal and Financial Risks
The IRS doesn’t care how you and your associate therapist agree to characterize your working relationship, even if your accountant and the worker’s accountant recommend an independent contractor status. They assess the economic reality, business control and more that define how the relationship functions.
An employee is generally considered anyone who performs services, if the business can control what will be done and how it will be done. What matters is that the business has the right to control the details of how the worker’s services are performed. Independent contractors are normally people in an independent trade, business or profession in which they offer their services to the public.
– IRS.gov, Worker Classification 101: Employee or Independent Contractor
The IRS and The Department of Labor (DOL) have a formal information‑sharing agreement, which lets DOL refer misclassification cases (including in healthcare) to the IRS’s employment‑tax unit, increasing the odds that payroll‑tax issues become IRS cases.
- Back taxes: You’ll owe all the employer payroll taxes you should have been paying (7.65% of wages), potentially going back years
- Penalties: The IRS can impose fines up to 100% of the taxes owed for each misclassified associate, depending on whether they determine the misclassification was intentional
- Interest: You may be asked to pay interest accrued on all back taxes from the date they were due
- State and local violations: In addition, most states and many cities/counties, impose their own fines for misclassification, not only for taxes but for mandated paid leave not provided to the individual –In addition to paid leave, there may be other mandated employee benefits, for example, Illinois requires that retirement plans be offered for workforce of five or more employees
- Legal fees: Many of the related laws require you to pay the individual’s attorneys’ fees for successful defense. Plus you will have the cost, risk, time and expense of legal defense if you are audited or sued
We’re not talking about a nominal penalty either. In 2023, California’s Labor Commission found a therapy firm willfully misclassified 1,280 therapists as independent contractors resulting in fines over $9 million. That may sound like an extreme case but small business owners can face bills in the tens of thousands of dollars for worker misclassification issues.
The severity of a penalty if misclassification is found (back taxes, interest, penalties, plus potential Department of Labor (DOL) and state actions) is high enough that owners should treat compliance as a core risk‑management issue.
Who Controls The Work: Clinical Autonomy vs. Employer Control
The IRS applies a common‑law control test that looks at behavioral control, financial control, and the overall relationship to decide whether a worker is an employee or an independent contractor. In practice, the more control your practice has over how, when, and where a therapist works, the more likely the IRS is to see them as an employee.
As a practice owner, it can be tempting to assume that paying a therapist a percentage of collections instead of an hourly wage, or not offering benefits, automatically makes them an independent contractor. But what you call the relationship in your contract does not control how the law classifies it.
How IRS Worker‑Classification Rules Apply in Therapy Practices
The IRS evaluates worker classification using three main categories: behavioral control, financial control, and relationship type.
These categories grew from a more detailed 20-point test the IRS used historically. While the IRS has streamlined its official framework, the 20 questions below remain useful for evaluating your specific situation. They translate the three broad categories into concrete factors that apply directly to therapy practices.
Let’s walk through how this framework applies specifically to therapy practices:
“Yes” answers here indicate Independent Contractor Status
Profit or loss: Can the worker make a profit or suffer a real economic loss beyond just not getting paid?
For therapists: Does the therapist invest their own money in marketing, rent separate office space, or risk financial loss if clients don’t show?
Reality check: If they’re seeing clients in your office using your EHR, probably not.
Investment: Does the worker invest in equipment and facilities?
For therapists: Do they provide their own furniture, pay for their own liability insurance, supply their own assessment materials?
Reality check: If you’re providing the office, computer, and practice management software, this points to employee.
Important note: A therapist bringing their own laptop or using their personal cell phone doesn’t count as significant investment. The IRS looks at substantial equipment and facilities—like the office space itself, furniture, EHR systems, and practice infrastructure. If you’re providing these major components, the fact that they use their own computer is irrelevant.
The telehealth complication: Many therapists now conduct sessions from their home, which can muddy the waters. However, working from home doesn’t automatically make someone a contractor. The fundamental questions remain: Do they operate a genuinely separate business? Do they have their own clients, their own billing, their own business entity? Or are they essentially remote employees seeing YOUR clients, using YOUR EHR, following YOUR procedures, and receiving clients through YOUR marketing? If it’s the latter, using their home office doesn’t change the employment relationship—it just means they’re working remotely, like millions of other W-2 employees.
Works for more than one firm: Does the person work for multiple practices simultaneously?
Are they a W-2 employee for another employer? How much time do they spend working for you relative to their outside work?
For therapists: Do they maintain their own separate practice while also seeing clients through yours? Do they have a PLLC or LLC?
Reality check: This can support contractor status, but it’s not enough on its own.
Services offered to the general public: Does the worker advertise their services?
For therapists: Do they have their own website, Psychology Today profile, and business cards separate from your practice?
Reality check: Simply having a personal website isn’t enough. The question is whether they operate a genuinely separate practice and get their own clients through their own marketing efforts. If they’re listed on YOUR website as part of YOUR team and that’s how most clients find them, their personal website doesn’t establish independence. It’s about whether they’re truly running their own business or just supplementing their employee role with a side presence.
“Yes” answers here indicate Employee Status
Direction: Do you tell the therapist when, where, and how to work?
For therapists: Do you require them to be in the office certain days/times? Use specific treatment approaches? Follow your policies for documentation?
Most practices: YES—this is employee status.
Training: Do you train them?
For therapists: Do you provide orientation, train them on your EHR, or require continuing education? Note that in many states, a supervised, provisionally licensed clinician must be a W-2 employee.
Most practices: YES—contractors should already know how to do the job.
Important distinction: All licensed therapists need continuing education to maintain their licenses—that’s a licensing requirement, not an employment indicator. What matters is: Are you paying for their training? Are you requiring specific trainings as a condition of working with you? Are you training them in your practice’s specific methods, protocols, or approaches?
If yes to any of these, that’s “behavioral control” indicating employee status. True independent contractors are responsible for their own professional development and training costs.
Integration: Are their services essential to your business?
For therapists: Is providing therapy services the core of what your practice does?
Obviously: YES—therapy is your business, so therapists are integral.
Services rendered personally: Must they do the work themselves?
For therapists: Can they send a substitute therapist to see their clients?
Most practices: Of course not – this screams “employee”.
Hiring assistants: Do you hire, supervise, and pay their support staff?
For therapists: If you provide admin staff, billing support, or supervision—this also indicates employee status.
Continuing relationship: Is there an ongoing and long-term relationship?
For therapists: Do they see clients regularly through your practice over months or years?
Most practices: YES—employee status.
Work hours: Do you set their schedule?
For therapists: Do you tell them which hours they need to be available?
Many practices: YES—even if it’s “some evenings and weekend hours,” you’re setting their schedule.
Full-time work: Must they dedicate significant time to your practice?
For therapists: Do you expect them to maintain a minimum caseload or be available certain days?
This indicates: Employee status.
Work done on premises: Must they work at your location?
For therapists: Are they required to see clients in your office?
Most practices: YES—employee status.
Sequence: Do you determine the order of their work?
For therapists: Do you require intake procedures, documentation timelines, or specific billing processes?
Most practices: YES—employee.
Reports: Must they provide you with regular reports?
For therapists: Do they document in your EHR? Provide clinical notes? Report on their caseload?
Obviously: YES—employee status.
Pay schedules: Do you pay by hour, week, or month?
For therapists: Even if it’s a percentage split, if you’re paying them regularly (not per completed project), this indicates employee.
Most practices: Employee status.
Expenses: Do you pay their business costs?
For therapists: Do you provide office space, EHR access, billing services, supplies?
Most practices: YES—massive indicator of employee status.
Tools and materials: Do you provide equipment and resources?
For therapists: Do you provide the office, furniture, computer, phone system, assessment tools?
Most practices: YES—employee status.
Right to fire: Can you terminate them at will?
For therapists: Can you end the relationship without a breach of contract lawsuit?
If yes: Employee status.
Worker’s right to quit: Can they quit without liability?
For therapists: Can they leave without fulfilling a contract term?
If yes: Employee status.
Critical Fact: Most Associate Therapists Are Employees
If you’re like most group practices, your associate therapists:
- See clients in YOUR office or virtually from their homes
- Use YOUR EHR
- Follow YOUR policies and procedures
- Document according to YOUR requirements
- Are scheduled during YOUR practice’s set hours of business
- Are listed on YOUR website as part of YOUR team
- Receive clients through YOUR marketing
- Use YOUR billing and admin support
Looking at those bullet points and the 20 factors above honestly, most associate therapists should be classified as W-2 employees. Calling them a contractor doesn’t change the reality.
Real Costs: 1099 vs W-2 for Therapy Practices
Let’s do some math. Say you’re paying an associate therapist $40,000 per year.
1099 Contractor (if misclassified):
- You pay: $40,000
- You think you will “save”: ~$3,060 in employer payroll taxes
- When IRS determines you misclassified that contractor, it costs you: ~$3,060 back taxes + ~$3,060-$6,120 in penalties + interest + state penalties + legal fees
- You will be liable for past paid leave (as far back as 5 years) and related penalties, such as 2 or 3 times the lost leave pay
- Actual cost: could be $20,000-$60,000+, depending on how far back the misclassification goes plus your and individual’s attorneys’ fees
W-2 Employee (done correctly):
- You pay: $40,000 salary + $3,060 payroll taxes + ~$2,000 workers comp + mandated leave/benefits + payroll and accounting costs
- Total: ~$45,500
- Risk: Nearly zero if done properly
- Actual cost: ~$46,500
The supposed “savings” of misclassification is a trap. Doing it right costs less in the long run.
What About Provisionally Licensed Therapists?
This goes back to control. An independent contractor does their work independently. They aren’t directed by you about how, when, or where their work is accomplished. If a therapist requires clinical supervision to practice, they cannot be a 1099 independent contractor. Period.
This includes:
- Grad and practicum students in academic programs with required field training placements
- LSWs, AMFTs, LPCs
- Psychology interns and post-docs
- Anyone who must have their clinical work overseen
The IRS is clear on this: if you must supervise their clinical work, that relationship fails the behavioral control test for independent contractor status and must be classified as W-2 employees.
What About Office Rental Arrangements?
Some practices try to structure arrangements where therapists are “renting office space” and operating independently. This CAN work, but only if:
- There’s a genuine office rental agreement (separate from any services agreement)
- The therapist pays market-rate rent
- The therapist has their own separate practice, business license, and EIN
- The therapist does their own billing & collection, scheduling, and client management
- Your business relationship is landlord-tenant, not practice owner-clinician
- The therapist isn’t presented as part of your practice
If you’re taking a percentage of their collections, providing billing services, listing them on your website, having them use your EHR or scheduling their clients—it’s not a rental arrangement. It’s employment.
Top 5 1099 Myths Debunked
Myth 1: “Hiring as a 1099 is cheaper for the practice.”
Reality: Only if you don’t get caught. Yes, you avoid the 7.65% employer payroll tax burden. But when the IRS determines misclassification, you’ll pay:
- All those back payroll taxes
- Penalties (often 100% or more of the taxes owed)
- Interest on the back taxes
- State penalties
- Legal fees to defend yourself
The “savings” evaporate instantly, and you’re left with a massive bill.
Myth 2: “1099 contractors can be paid a higher percentage.”
Reality: You can pay employees any percentage split you want. Payment structure doesn’t determine classification.
You could pay an employee 70% of collections if that’s your model—it’s the control factors that matter, not the compensation method or amount.
Myth 3: “Therapists want 1099s because they can deduct more professional expenses.”
Reality: Most therapists who believe this are misinformed about tax law. Yes, contractors can deduct business expenses, but:
As an owner, you can’t let someone be misclassified just because they want to be. Their agreement – or even request – to do so is not a defense to a misclassification claim.
The math rarely works out in the contractor’s favor unless they have substantial legitimate business expenses
As a W-2 employee, the worker pays 7.65% in payroll taxes (their half), and the employer pays the other 7.65% (the employer’s half), for a total of 15.3%
As a 1099 contractor, the worker pays the full 15.3% themselves (this is called “self-employment tax”)
W-2 employees can still deduct unreimbursed business expenses in many cases.
Myth 4: “Temporary or PRN (as-needed) workers can be 1099 contractors.”
Reality: The temporary nature of work doesn’t determine classification—control and integration do.
If you hire a therapist to cover for someone on paternity or maternity leave, or you bring in a PRN (as-needed) therapist for occasional coverage, they’re still likely W-2 employees.
If you control when and how they work, if they use your office and systems, and if they see your clients following your procedures – they are employees.
Myth 5: “A signed independent contractor agreement protects me.”
Reality: The IRS doesn’t care what your contract says.
They care about the actual working relationship. A contract calling someone a contractor when they function as an employee won’t protect you. It might actually make penalties worse by suggesting you knew the rules and intentionally violated them.
Who Can Be a 1099 Contractor in a Therapy Practice?
There are some roles that CAN legitimately be 1099 contractors if structured correctly.
- External clinical supervisors who are paid per supervision session, set their own schedules, supervise multiple supervisees from different practices, and aren’t integrated into your daily operations
- Consultants hired for specific projects (website development, marketing campaigns, one-time trainings)
- Bookkeepers who serve multiple clients, work from their own office, use their own software, and set their own schedules
- Billing specialists who run their own billing business serving multiple practices
- Fully licensed therapists who maintain their own completely separate practice, rent office space from you on a pure office rental basis, handle their own billing, collections and clients, and truly operate independently (not sure what you would be paying them for, in this case)
1099 “Independent” Contractors Must Be Independent
A 1099 worker must have genuine independence and bear real business risk. They control when, where, and how they work. They serve multiple clients, invest in their own business, and handle their own billing and collections.
Here’s the money test: If clients pay your practice and you then pay the therapist a percentage split, that’s employee status. You control the money flow, the client relationship belongs to your practice, and billing has your practice’s name and EIN.
If money flows through your practice first, that may be a sign the therapist is an employee, regardless of what your contract says.
Recap: When Should a Therapist Be Classified as a W-2 Employee?
If you’re building a group practice, your associates are W-2 employees. Here’s a framework to help you decide what’s right as you grow your practice:
Your Associates Are W-2 Employees If:
- They’ll see clients in your office
- You’re providing office space, equipment, EHR access, and admin support
- You set their schedule or require minimum availability
- They’ll be listed on your website as part of your team
- You’re marketing on their behalf
- They need clinical supervision
- They’ll be using your billing services
- You want the ability to train them in your practice’s approach
- You want control over quality and client experience
This describes most group practice scenarios.
1099 Independent Contractors Are Unusual:
A therapist can only be classified as an independent contractor if they:
- Maintain a completely separate, independent practice
- Handle 100% of their own billing, collection, scheduling, and client management
- Provide their own equipment and supplies
- Market themselves independently and get their own clients
- Are fully licensed (no supervision required)
- Bill clients directly under their own business name and EIN
- Have NO integration with your practice operations
This is rare in traditional group practices.
Most group practice owners who want to expand are building a team model, which inherently means W-2 employees, not independent contractors.
Worker Classification for Therapy Practices is About What the Law Requires
The question isn’t which worker classification option is preferred or better for your short term financials. It is about what the law requires based on how your practice operates and what the economic reality is for your workers.
Getting your worker classification right from the start protects your practice from penalties that can reach tens of thousands of dollars. Once you set up proper payroll and employment practices, it becomes routine. Your bookkeeper or payroll service handles the tax complexity, and you gain legitimate control over quality and client experience.
The supposed cost savings of misclassification disappear the moment the IRS or Department of Labor comes calling. Don’t let misinformation cost you your practice. Get it right from the start and build your group practice on a solid legal and financial foundation.
Employee Classification Check for Therapy Practice Owners
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Resources and Next Steps:
- IRS Resources: IRS.gov has detailed guidance on worker classification
- IRS Amnesty Program: Voluntary re-classification for future tax periods
- Legal Counsel: Consult an employment attorney licensed in Illinois
- Accounting Support: Work with a CPA experienced in therapy practice structures
- Payroll Services: Work with an independent bookkeeper experienced in therapy practices or consider payroll services like Gusto, ADP, or Paychex to handle the tax complexity
I want to thank Lori Goldstein, employment attorney, for reviewing and contributing to this article.
This article is for educational purposes only and does not constitute legal or tax advice. Every practice’s situation is unique. Please consult with qualified legal and tax professionals before making decisions about worker classification.
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