Can a small company (sole proprietership) issue an employee a 1099M instead of a W-2? Are there penalties for doing so? The man worked as an employee in every way, yet had no Social Security paid or taxes withheld by the employer. He was in no way an independent contractor. He did what he was told under direct supervision at the employers place of work and on the employer's schedule.

Thanks.

You can file Form SS-8 with IRS to request determination of your status for purpose of federal employment taxes.
Read: Your U.S. Tax Return: W2 vs 1099-Misc: Employee vs Independent Contractor. (http://taxipay.blogspot.com/2008/03/w2-or-1099-employee-or-independent.html)

Yes, he CAN file SS-8 to get the IRS involved, but doing so will probably get him terminated, even in states which have laws preventing such retaliation.