What is the difference between W-2 Employees and 1099 contractors?

What are the advantages and disadvantages of hiring W-2 employees or 1099 contractors?

Understanding the differences between W-2 employees and 1099 contractors is vital for any business owner. The distinctions can be confusing but are not complicated—and both present advantages and disadvantages, depending on your circumstances.

What is a W-2 employee?

Form W-2 applies to the type of worker we generally think of when we hear the word “employee.”

A W-2 employee is on your payroll, works according to your schedule, and has payroll taxes deducted throughout the year from the paychecks that you issue to them. These employees can be full-time or part-time, but the law guarantees them at least the minimum wage.

W-2 is the default classification, and any worker who is not a 1099 contractor is, generally, a W-2 employee.

What is a 1099 contractor?

Self-employed workers or entities, including freelancers and gig workers, fall under the IRS classification of independent contractors. What does it mean for a worker to be self-employed?

Simple: they are business owners, and the service they provide is defined by their business. An independent contractor is usually hired to provide specific work, as outlined in a contract. However, they maintain autonomy in terms of the completion of the work and pay their own taxes.

In the case of both types of workers, you, as the employer, are responsible for issuing the appropriate year-end form, either a W-2 or 1099, showing the total amount that the worker earned during the tax year.

The type of business you operate, the nature and objectives of the work required, the level of control you want to exert over the work, and your bottom line can all be factors in deciding which type of worker to hire.

Both can offer benefits and challenges, and the right choice will depend on your specific circumstances.

When should you hire a W-2 employee?

While hiring a W-2 employee can be the costlier choice, it may be the right one if your business is ready for continuity, consistency, and control over the work gets done.

Do you want your workers to develop loyalty, accountability, and mastery over the work? Do you need someone to show up to a set location according to your schedule and consistently execute necessary tasks? Then you should most likely hire a W-2 employee.

There are costs involved. Beyond wages, you will also have to pay your employee’s Social Security and Medicare taxes upfront, and you may need to provide benefits, such as paid time off or health insurance.

You will also have to provide all resources your employee will need to do their job, including skills training and tools. Training, managing, and motivating your employees can be an ongoing necessity, and terminating a W-2 employee can be more complex than a 1099 contractor.

There are valuable benefits as well.

Employees tend to be more loyal to a company, you have more direct say over their day-to-day work, and as they gain experience, they can add increasing value over time. This can manifest as a better work ethic, higher morale, a wider talent pool, and increasing returns on the initial training you provide.

There is a significant amount of friction in hiring, training, and managing new contract workers, so the continuity of W-2 employees drives down long-term costs.

When should you hire a 1099 contactor?

If the work required is inconsistent, seasonal, or short-term, you will most likely want to hire a 1099 worker.

Independent contractors typically fill specific task roles or do specialized projects. Work you will need regularly, but which will remain limited in scope and time, may also call for hiring a 1099 worker.

For example, most businesses’ bookkeeping is a regular function but may not take enough time each week to justify hiring a W-2 employee. (And just happens to be something we can take off your hands, contact us here to get started).

Outsourcing to an independent bookkeeper demonstrates another critical advantage of 1099 workers: specialized expertise.

While you are responsible for providing training and resources to a W-2 employee, independent contractors usually are already well-trained and experienced in the type of work you hire them to complete.

Finally, since independent contractors are self-employed (or employed by others) and do not work for you beyond the scope of the given project, you do not need to withhold or file payroll taxes nor provide benefits or overtime. The contractors themselves (or their employers) are responsible for paying their own self-employment taxes.

Naturally, there are potential disadvantages of hiring a 1099 contractor, too.

An independent worker…works independently! That means you have less control over when and how the work gets done. So if you have hired an independent contractor to work within a business staffed by W-2 employees, the result can become disruptive.

There are also legal considerations. If a 1099 worker suffers an injury on the job, you could be liable. And finally, when the job is complete and the contractor leaves, their specialized expertise goes, too.

That said, however, if you are an attorney, you would never hire and train a W-2 employee to fix an electrical issue or provide IT Consulting. The services of an independent contractor better address some jobs.

The IRS may decide that your 1099 contractor is an employee

One question is whether you want or need an employee or a 1099 contractor. But regardless of what you want or how you think a worker fits into your business, the IRS may disagree.

The bureaucratic ease of 1099 contractors can make them appealing to small businesses.

However: if you substantially control a contractor’s work, including the work they do, when they work, and the tools they use, the IRS may decide that these workers should be W-2 employees. This can lead to fines and back taxes.

What are your responsibilities?

No matter what kind of worker you hire, you will have certain obligations.

In the case of wage and salaried employees, you are responsible for preparing and providing each worker with their W-2 form on or before February 1st.

You will also need to send copies to the Social Security Administration and your state tax authority if required. Failure to do so before this deadline can result in severe fines for your business. If a W-2 form is incorrect or goes missing, your business will have to replace the form before the filing deadline. Employers are also obligated to keep all W-2 forms on file for at least four years.

Managing W-2 forms can be a lot of work, which is why many companies outsource these tasks to Professional Employer Organizations (PEO’s) or payroll companies.

Although independent contractors are responsible for their own income taxes, businesses or individuals who hire them must issue a 1099 form to the contractor and file it with the IRS for $600 or more payments.

This applies either to single payments exceeding that amount or total payments over the course of one tax year.

You must prepare and deliver the 1099 form by the end of January following the tax year in which you made the payments. How and when the worker files their copy after that is not your responsibility.

In closing…

With this information in mind, you will be in a much stronger position to understand which type of worker best suits the needs of your business, the pros, and cons of each, and what responsibilities you will assume upon hiring.

Would you like some help?

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