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When starting a business, you often do not have the funds or the work to hire full-time employees. So, you hire contractors to help you grow. This is fine as long as contractors are doing part-time, contract-type work. However, as your business grows, this part-time work can become full-time, and your contractors become employees.
From the IRS’s perspective, the two most common classifications and the forms you use for reporting, withholding, and paying taxes are:
Sometimes, it can be challenging to determine whether you should hire somebody as a W-2 or 1099 worker. However, the difference is critical, as each classification creates different payroll tax implications for you.
The IRS requires you to correctly determine whether the individuals providing services for your business are employees or contractors, and misclassifying someone can have serious financial consequences.
Therefore it is vital to understand the differences between hiring W-2 versus 1099, how they apply to your situation, and which type of worker will best suit your needs.
Here are some key considerations when deciding whether hiring a W-2 employee or a 1099 contractor is the best choice for your business.
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.
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.
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.
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.
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.
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.
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.
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.
If you are a client and would like to book a consultation, call us at +1 (212) 382-3939 or contact us here to set up a time.
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Jeff Coyle, CPA, Partner of Rosenberg Chesnov, has been with the firm since 2015. He joined the firm after 20 years of business and accounting experience where he learned the value of accurate reporting, using financial information as a basis for good business decisions and the importance of accounting for management.
He is a diligent financial professional, able to manage the details and turn them into relevant business leading information. He has a strong financial background in construction, technology, consulting services and risk management. He also knows what it takes to create organizations having built teams, grown companies and designed processes for financial analysis and reporting.
His business experience includes:
Creating and preparing financial reporting, budgeting and forecasting.
Planning and preparation of GAAP and other basis financial statements.
Providing insight on financial results and providing advice based on those results.
Jeff also has a long history of helping individuals manage their taxes and plan their finances including:
Income tax planning and strategy.
Filing quarterly and annual taxes.
General financial and planning advice.
Prior to joining the firm in 2015, Jeff was in the private sector where he held senior financial and management positions including Controller and Chief Financial Officer. He has experience across industries, including construction, technology and professional services which gives him a deep understanding of business.
Jeff graduated from Montclair State University, he is a CPA and member of the American Institute of Certified Public Accountants, New York State Society of Certified Public Accountants and New Jersey State Society of Public Accountants.
Jody H. Chesnov, CPA, Managing Partner of Rosenberg Chesnov, has been with the firm since 2004. After a career of public accounting and general management, Jody knows the value of good financials. Clarity, decision making, and strategy all start with the facts – Jody has been revealing the facts and turning them into good business results for more than three decades.
He takes a pragmatic approach to accounting, finance and business. His work has supported many companies on their path to growth, including helping them find investors, manage scaling and overcome hurdles. His experience and passion for business reach beyond accounting and he helps businesses focus on what the numbers mean organizationally, operationally and financially.
He has a particular expertise in early-stage growth companies. His strengths lie in cutting through the noise to come up with useful, out of the box, solutions that support clients in building their businesses and realizing their larger visions.
Prior to joining the firm in 2004, Jody was in the private sector where he held senior financial and management positions including General Manager, Chief Financial Officer and Controller. He has experience across industries, which gives him a deep understanding of business.
Jody graduated with a BBA in Accounting from Baruch College, he is a CPA and member of the American Institute of Certified Public Accountants and New York State Society of Certified Public Accountants.
In addition to delivering above and beyond accounting results, Jody is a member of the NYSCPA’s Emerging Tech Entrepreneurial Committee (ETEC), Private Equity and Venture Capital Committee and Family Office Committee.
He is an angel investor through the Westchester Angels, and has served as an advisor for many startup companies and as a mentor through the Founders Institute.
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