What Is the Difference Between a 1099 and a W2 Employee?
The 1099 and W2 tax forms are used to deduct payroll taxes from various kinds of workers. Employees with a 1099 status are self-employed independent contractors. They are paid according to the terms of their contract and get a 1099 form on which to declare their earnings on their tax return. A W2 employee is paid a regular salary and receives benefits. The employer deducts income taxes from the employee’s salary and exerts considerable control over the employee’s job.
One of the most difficult parts of operating a small company is managing human resources. You’ll be responsible for onboarding, payroll administration, employee interactions, and other critical HR duties if you don’t have a specialized HR staff. In addition to the time expenses of these duties, you must factor in the monetary costs of personnel, which may range from 40% to 80% of your company’s budget, depending on your sector! 
Because of this cost, many small company owners debate whether to hire a 1099 or W2 employee for specific jobs. Hiring 1099 employees, often known as independent contractors, may help you save money while also reducing your legal obligations.
There are significant distinctions between these two kinds of employees, and correctly categorizing them with the IRS is critical. Otherwise, you risk facing IRS fines or possibly a lawsuit against your company. As a result, when categorizing employees, we suggest enlisting the help of an employment attorney.
Aside from legal concerns, both employing employees and independent contractors has benefits and drawbacks. You want to make the best decision for your company. Here, we’ll go over the differences between 1099 and W2, as well as the differences between a 1099 employee and a W2 employee, when to hire either, and specific examples you can use in your small company.
What’s the Difference Between a 1099 Worker and a W2 Employee?
Let’s begin by examining the distinctions between a 1099 and a W2 employee. Both are called after the tax forms they are used for: Employers submit Form W2 on behalf of their workers, and companies send Form 1099-MISC to independent contractors they deal with.
Although both independent contractors and employees offer critical services to the small companies for which they work, there are a few key distinctions. It’s critical to understand these distinctions since misclassifying an employee as an independent contractor may result in expensive penalties and legal costs. W2 employees who are misclassified as independent contractors may sue your company for benefits such as health insurance, overtime pay, and the minimum wage that they were refused.
To help you differentiate between the two, we’ll go through the essential identifiers for both kinds of employees and how to tell them apart.
What Does a 1099 Employee Mean?
A 1099 worker, often known as an independent contractor, performs particular services that are outlined in a signed contract. While some 1099 employees concentrate on a single project at a time, many others serve many customers and provide a service within their area of expertise. Freelancers and consultants are examples of independent contractors who are self-employed and therefore company proprietors.
W2 workers are often hired with the aim of working with them for an indefinite period of time. Businesses, on the other hand, hire independent contractors for a certain length of time and under specific terms specified in the contract. However, the engagement may be renewed as many times as both the 1099 employee and the company owner see fit.
Independent contractors, regardless of the duration of their contract, choose how and where they work, as well as the equipment and techniques they use to accomplish the job you paid them to do. 1099 workers have the option of hiring their own employees to assist them in delivering the product or service you hired them to offer. In other words, when independent contractors do their tasks, they take on the risk of making a profit or losing money.
Because you have a limited degree of control over independent contractors, you also have a low level of financial and legal obligation. Because 1099 employees pay both employee and employer self-employment taxes, your company won’t have to pay payroll taxes if you hire an independent contractor. Furthermore, since they are self-employed, 1099 workers are not entitled for the same benefits as W2 employees, such as health insurance, paid time off, and overtime.
What is the definition of a W2 employee?
A W2 employee is what we usually think of when we think of a paid worker. W2 employees, unlike independent contractors, do not own their own company. They work for your firm, engage in employee benefit plans, and work according to the requirements and schedule of your organization. The default categorization for a worker is W2 employee unless there is a compelling cause to categorize them as an independent contractor.
Employees are required by law to be paid at least the federal and state minimum wage for hours performed on a regular and continuing basis. Employers deduct Social Security and Medicare taxes from W2 employees and pay employer payroll taxes. A business may usually fire an employee for poor performance or any other legitimate, non-discriminatory cause. In contrast, an independent contractor works and is paid according to the terms of a written contract between the parties. They are also responsible for their own taxes.
W2 workers are provided with the required equipment and materials by their employers. Independent contractors are responsible for their own supplies. Furthermore, workers are usually compensated for business expenditures incurred during their employment. Unless it is explicitly stated in their contract, this is not usually the case with independent contractors.
All qualified workers at a company are eligible for benefits such as health insurance, retirement contributions, and flexible spending accounts. Benefits are not accessible to independent contractors who work for a company, as previously stated.
How can you know whether your employees are 1099 or W2 employees?
We previously discussed how important it is to properly categorize your employees as 1099 or W2 employees with the IRS. Cost and convenience are often the deciding considerations for a company owner when deciding whether to hire a contractor or hire an employee. To be honest, paying a contractor is considerably simpler than managing payroll and other HR tasks needed of a company with workers.
However, any cost and time advantages will vanish fast if you are audited by the IRS or the Department of Labor and discover that you have misclassified employees. Because the IRS is strict when it comes to 1099 vs. W2, they may collect back taxes and penalties totaling more than 40% of the contractor’s income. You may also be required to pay back wages dating back three years by the Department of Labor.
Although the distinction between 1099 and W2 employees may be a little hazy, the IRS offers some advice on how to properly categorize your employees. When deciding whether workers are employees or independent contractors, the IRS looks at three factors:
Behavioral – Can your company manage what, where, how, and when the employee performs their duties?
Financial – Who is in charge of the worker’s financial well-being? What is the payment mechanism (for example, a regular income or a flat fee)?
Type of relationship – Do you provide this employee any benefits? What is the duration and conditions of this connection, as defined by a contract, an employment agreement, or other written documentation?
The amount of control a company has over an employee is what the employee categorization procedure comes down to. The worker is most likely a W2 employee if the business controls the majority of the job. The individual is most likely a 1099 independent contractor if they have a high level of freedom.
Even after considering the three criteria listed above, are you unsure if a member of your team is a 1099 or W2 employee? Fill out Form SS-8 and send it to the IRS. In such scenario, the IRS will decide how you should categorize your workers on your behalf. The IRS may take up to six months to make a decision, which is beneficial if you often recruit for the same kinds of positions.
Which Is Better for Your Business: 1099 vs. W2 Employee?
Now that we’ve established the distinction between an independent contractor and a W2 employee, we can address the issue you’ve undoubtedly been asking yourself: “1099 or W2 – which is better for my employee and my business?”
Because of the apparent cost reductions, many small company owners choose to deal with independent contractors. When you recruit W2 employees, you must pay employment taxes, workers compensation insurance, and overhead expenditures like office space and break-room supplies. These are all essential expenses that may rapidly erode a company’s bottom line. You’ll also need to consider the benefits and drawbacks of the W2 vs. 1099 tax forms.
1099 Independent Contractors Have a Lot of Benefits
Bring specialized knowledge — Working with an independent contractor has several advantages, including the ability to concentrate on one thing and execute it effectively. If your job requires highly specialized design or technical knowledge, you’ll almost certainly be able to locate an independent contractor who has established a company around it.
Provide more flexibility — Rather of hiring a full-time employee who will remain with your business for the long term, you may engage an independent contractor for a project or two as needed. When the company’s objectives and resources change, you’ll have greater freedom.
Independent contractors are not eligible for worker’s compensation, can’t pursue most kinds of wrongful termination claims, and generally carry their own professional insurance, posing a lower legal risk to your company. As a result, your company’s legal risk is reduced.
Reduces company expenses – Cost is an essential consideration, and using a 1099 employee rather than a W2 employee may help you save money. Independent contractors are not entitled to a minimum salary, overtime, or benefits. Another noteworthy W2 vs. 1099 tax difference is that when you employ independent contractors, you don’t have to withhold income taxes or pay payroll taxes, so your business has less paperwork to deal with.
W2 Employees Have a Lot of Benefits
Dedicated to your business – Employees that are treated well may pay off handsomely for your company. They will be devoted to your business and will go above and above by providing excellent service. There are a lot of great independent contractors out there, but you’re usually just one of many clients.
Provide greater consistency — Employees are in it for the long haul, and they can help with whatever your company requires at any given moment. You may depend on your workers to assist you if you need someone to change focus or contribute to a project on short notice, for example. Independent contractors, on the other hand, typically specialize in one field.
Free up the time of the company owner – Being a small company owner entails wearing a variety of hats, and you may feel as if you never get a break. Having staff enables you to assign particular duties for the long term, removing them from your to-do list. This allows you to concentrate on more strategic company choices.
They just need to be trained once — As part of their initial onboarding process, employees must undergo training. After that, they should get frequent training, but they’ll be familiar with the company’s rules and expectations. You can’t always expect independent contractors to produce work that matches your requirements since they aren’t part of your onsite team.
Finally, you can’t tell if a 1099 employee is better or worse than a W2 employee on a broad scale. The decision between a 1099 employee and a W2 employee is based on your company’s budget, the kind of work, and how much control you want over the process and end result.
Although independent contractors’ services may be more costly than those of an employee, their experience may frequently result in a higher-quality output. When you hire an independent contractor, though, you give up control over how, when, and where they work. That may be a no-no for certain small company owners. Employees suit this model more than independent contractors, since many small firms see themselves as one big family.
When deciding whether to hire 1099 or W2 workers, there are several factors to consider. Consult the chart below for assistance. This section outlines several particular situations in which you may choose to hire an independent contractor over an employee, and vice versa:
When Should You Use a 1099 vs. a W2? W2 vs. 1099 for employees
|SCENARIO||W2 EMPLOYEE||INDEPENDENT CONTRACTOR|
|You’re working on a short-term project and need temporary assistance to finish it.||An independent contractor is ideal in this situation since they can use their skills to finish the job more quickly.|
|You own a retail store, and during the holiday season, your traffic and sales skyrocket.||A W2 employee is the best option for this situation since you require your employees to be on site at your shop on a set schedule.|
|There is a function in your company that has to be performed on a regular basis, such as accounting, but it only takes a few hours each week.||You could hire someone to handle your bookkeeping and find additional tasks to keep the work interesting, but outsourcing it to an independent contractor who specializes in bookkeeping or accounting is frequently a better option.|
|You’ve had a string of poor luck with workers in the past, so you’d want to “test drive” a prospective employee’s abilities and work ethic before employing them on the spot.||If you are controlling when, when, and how the worker completes their tasks, even on a trial basis, they should be regarded as a W2 employee rather than an independent contractor.|
|Your company has a set of clearly defined procedures that must be followed in order to create your product or service.||Hiring a W2 employee and educating them in your company is the greatest choice in this situation.|
As you can see, using the services of an independent contractor rather of hiring an employee makes sense in certain situations. Other times, though, you’ll need to pay someone to do the task. If you’re still undecided about the kind of employee to recruit, there may be some more options available to you.
Are you unsure whether to hire 1099 or W2 employees? Take a Look at These Staffing Alternatives
If you’re not sure whether to recruit a 1099 or a W2 employee, temp agencies and professional employer groups are two options that incorporate some aspects of both. Both of these alternatives provide you with a pool of competent workers without the hassle of categorizing them as 1099s or W2 employees.
When Should You Use a Temporary Staffing Agency?
Seasonal companies or firms who wish to “test drive” or lease a person before employing them full-time might consider utilizing a temp agency’s services.
When you use a temp agency, they handle everything from hiring to interviews to background checks to timely payroll processing and tax payments. The temp agency also bills your company for the employee’s pay and taxes, as well as a service fee for the agency’s administrative services. You don’t have to worry about tax filings, workers compensation insurance, or other human resource problems since this invoice is recorded as a basic business expenditure on your records.
On paper, the temp agency, not you, is the worker’s formal employer (unless the job is a “direct hire”). You, on the other hand, get to determine how long the employee will work for your business and what their daily responsibilities will be.
This approach is more expensive than managing your own seasonal or temp-to-hire staff, but the time savings may be worth it. Just don’t lull yourself into a false feeling of security. Even if the temp isn’t your direct employee, you may still be held liable if anything goes wrong at work, such as a workplace accident. When temp agencies serve as a middleman, worker quality may be an issue.
The Advantages of Using a PEO to Staff Your Company
Temporary employment agency are a temporary answer to short-term job issues. However, a professional employer organization, or PEO, is a longer-term option. PEOs allow companies to outsource HR functions such as payroll, workers’ compensation, and benefits while maintaining control over the employee’s daily duties.
PEOs can also take advantage of the large number of employees they manage across companies to negotiate better benefit packages than small businesses can. PEOs charge a fee for their services, much like temp agencies, but the advantages may exceed the expenses.
Both your business and the PEO are co-employers of the employee. On a daily basis, you manage the employee, but the PEO is the employee’s go-to person for anything administrative or HR-related. A formal PEO agreement will spell out how duties will be shared.
Whether you use a temporary agency or a professional employer organization (PEO), it’s critical that you do your homework. Request references from the temp agency or PEO, and follow up with other small business owners who have used their services.
You should also hire an attorney to review any agreement with a temp agency or PEO before you sign it, as you should with any business contract. This guarantees that you aren’t unintentionally taking on obligations that you think should be covered by the temp agency or PEO.
W2 vs. 1099
Employees on 1099 vs. W2: A Difficult Decision
Staffing your company with the best possible employees is one of the most important tasks you’ll face as a small business owner. The issue is, which kind of employee should you hire? Here’s a short refresher on the subject.
Independent contractors, often known as 1099 employees, are self-employed. You can employ 1099 workers for particular tasks, but you have no control over when or how they finish. You won’t be liable for their Medicare and Social Security taxes, and you won’t be able to offer them with the same benefits as a W2 employee. This may be a more cost-effective alternative.
W2 employees, on the other hand, need a consistent pay, some perks, and more hands-on supervision. W2 employees may have greater financial expenses than 1099 employees. However, having a stable team of workers on hand, whom you’ve educated and can manage according to your standards, may be preferable.
Before you make your choice, think about a few things. This covers the kind of work you need, how soon you require it, whether the project is a one-time or ongoing commitment, and the expenses associated with employing 1099 vs. W2 employees.
Before making a final choice on how to consult your company’s employees, it’s important to consult an employment law and a tax expert.