How Does a Business Owner Choose Between a 1099 vs. W2 Employee?
If you took a poll of all small business owners of one of the more difficult aspects of running a business, most would probably say that managing human resources provides the most challenges.
Without a dedicated HR team, payroll, handling employee taxes, and other vital HR tasks fall on the employer. It is important to recognize the many challenges an employer faces when it comes to staffing. Time and money are not a company’s only concerns. In addition, staffing costs in finding qualified employees can affect your bottom line.
Given the consideration of profit margins, small business owners face hiring W2 or 1099 employees for certain positions. Hiring 1099 workers can provide relief on the cost of payroll taxes, other payroll-related expenses, and legal responsibilities.
Employee misclassification can be a costly mistake…
Regarding the IRS, making sure to classify these employees the right way is significant. If you don’t handle this distinction properly, penalties or lawsuits from the IRS could be a reality for your business. If you’re unsure of the correct employee classifications, consult an employment attorney to ensure you get it right.
As a small business owner, you need to research many factors before finding out whether a W2 employee or 1099 independent contractor is the right move for your company. Below we’ll discuss the differences between 1099 contractors and W2 employees, along with the pros and cons of each type of worker.
What’s the Difference Between 1099 Independent Contractors vs. W2 Employees?
As stated previously in this post, the main difference between W2 employees and 1099 contractors is that 1099 contractors are hired for specific projects or tasks. W2 employees have a full-time job with the company, and benefits often come with that position.
Employers withhold income tax from federal, state, and local governments and other taxes from the employee’s paycheck and have more say over the employee’s work at the company.
W-2 employment is more expensive for employers because of the costs of providing those employee benefits packages, including health insurance, retirement plans, disability insurance, unemployment insurance, paid vacation time off, social security, and Medicare taxes.
1099 independent contractors are self-employed freelancers and usually receive payments according to the terms of a contract. They report income on their tax return with the IRS by getting a 1099 misc tax form.
Let’s dive deeper into what distinguishes 1099 contractors and W2 employees.
What is a W2 Employee?
A W2 employee is a salaried worker who is usually employed full-time.
An employer has to withhold income taxes, payroll taxes, deductions for Social Security and Medicare contributions, provide employees with employment benefits such as sick days, health insurance coverage, disability insurance, holiday pay, and more. These benefits are generally not available to 1099 workers.
W-2 employees are your company’s workforce, participating in employee benefit programs and fulfilling business needs. For the most part, employees are classified as W-2 workers unless there’s a specific reason why they should be classified as independent contractors.
W-2 employees are legally entitled to at least a minimum wage, usually the higher amount determined by federal and state law. In contrast, 1099 workers are generally paid on a per-project basis.
Your company has the right to terminate an employee for poor performance or any other non-discriminatory reasons. Independent contractors receive compensation based on contract terms. Independent contractors are also responsible for paying their own taxes.
Employers provide all the necessary tools and supplies for W2 employees. Independent contractors must provide their own. In addition, employees are typically reimbursed for business expenses they incur over the course of their employment. This is typically not the case for independent contractors unless specifically outlined in their contract.
Another difference between 1099 vs. W2 employees is that employees generally have their work expenses reimbursed. Still, if you’re a 1099 worker, it’s up to you to provide all the supplies and things needed to get the job done yourself.
What Are 1099 Contractors?
An independent contractor is someone who provides a specific service in exchange for compensation. 1099 workers are all over the map. Some only work on one project at a time, but many serve multiple clients.
You might say that a 1099 independent contractor is a business owner because they are technically self-employed and cover all of their own expenses along with their own taxes when they receive a form 1099 misc from their employer. When a business hire’s them, the business is essentially their client.
W2 employees are typically hired for an indefinite period of time while independent contractors work on a contract basis. This way, companies can tailor the length of their contracts to each contractor’s needs and budget constraints without worrying about negotiating terms with every W-2 worker they hire.
Independent contractors are individuals that get to decide how they work, where they work, and what tools or methods are used to complete the job you have hired them for. People that take stock in a good work-life balance often prefer being an independent contractor. However, because you’re technically self-employed and your reputation is what gets you work, you might have to work longer hours to ensure the job is done right for your client.
1099 workers can also choose if they want help completing their own task by hiring someone else. Independent contractors take on the risk of profit and loss from carrying out a project.
Hiring an independent contractor is a great way to reduce or avoid payroll tax. Independent contractors pay both employee and employer self-employment income taxes, so you don’t need to worry about paying any at all! 1099 workers are also ineligible for benefits like health insurance that your W2 employees enjoy.
With the lower costs, hiring an independent contractor can be cost-effective for companies even if they charge more per hour than W2 employees.
How Do You Determine 1099 workers vs. W-2 employees?
Earlier in this piece, we discussed the significance of 1099 vs. W-2 employee classification filing with the IRS. When an employer is deciding whether to hire someone as an employee or engage them as a contractor, the cost and ease of the agreement are often what they weigh before choosing one over the other. Paying a contractor is easier than handling payroll and HR functions necessary for a business with W-2 employees.
But misclassifying your workers could lead to a hefty penalty. The IRS can levy back taxes and penalties if they find you’ve acted in bad faith and misclassified 1099 & W2 employees, while the Department of Labor may require that you pay wages going back three years.
In some cases, it can be tough to classify employees and workers correctly. The IRS provides some guidance about correctly classifying your workers. Should you classify them as employees or independent contractors? The three major categories are:
- Behavioral – Can your company tell the worker what to do, where to work, and when to take a break? What’s the degree of company control?
- Financial – Who controls the financial aspects of an individual’s work? Do they get paid a salary or a flat fee?
- Relationship – Does this worker get employee-type benefits? How long does this agreement last? Are there any specific terms to the relationship outlined in documentation, such as a contract or employment agreement?
The classification of workers comes down to how much control companies have over a worker. If the employer controls most business aspects, then they’re probably classified as a W-2 employee, while 1099 independent contractors typically enjoy more independence when it comes to their work.
With so many conflicting factors, it’s hard to know who is an independent contractor and who isn’t. So if you’re unsure about the classification of one of your workers, you can file IRS form SS-8, and they will review each case and decide the correct classification.
1099 vs. W2: What Works Better for Your Business?
If you’ve gotten this far, then by now, you know the difference between a 1099 worker and a W-2 employee. So which type of worker is better for your business?
Many employers prefer to hire self-employed independent contractors to decrease the blow to the bottom line. For W-2s, employers have to pay employment taxes, unemployment tax, medicare taxes, social security tax, workers compensation insurance, and other withholding taxes.
Besides the cost aspect, employers must weigh other benefits and disadvantages in choosing a 1099 vs. W2 worker.
The Pros of Hiring W2 Employees:
- No need for perpetual onboarding – For an onsite team of W-2 employees, training is a part of their onboarding process. They generally receive subsequent training after that from time to time to keep up with company policy. For independent contractors who are not members of your own staff, you’d need to repeat the onboarding process with each one, so they get acquainted with your company and the level of work you expect from them.
- There when you need them – When you need a helping hand in the office, your employees are there for you. They can help with any project or task that needs to be completed on short notice, but their loyalty guarantees they’ll be an asset of long-term value. Independent contractors may have skills and projects that surpass those offered by other companies; however, their time is limited due to prioritizing personal pursuits over company obligations.
- There for you and only you – Giving your employees the right treatment can pay off for many reasons. They will feel loyal to your company, do their best work, or even go above and beyond when you need them most. Don’t forget that independent contractors also have many potential benefits, but their time is spread out for various clients.
- Delegate tasks – The idea of starting your own business is exciting yet terrifying. You’re faced with a never-ending list of tasks to complete, and you don’t know where or when the next break will come from. The good news? Taking on employees can help take some pressure off! This way, you have someone else wearing all those hats for once so that they’re constantly available while still able to focus on higher-level tasks.
The Pros of Hiring 1099 Workers:
- Helps the bottom line – Hiring a 1099 employee is a great way to save on payroll and paperwork costs. You don’t have to pay an independent contractor a minimum wage, pay overtime, or provide any benefits – you hire them for a project, figure out their compensation, and pay their invoice!
- Minimizes legal issues – Independent contractors are exempt from the same rules as W-2 employees. Employers don’t have to worry about worker’s compensation or wrongful termination claims. 1099 employees also carry their own professional insurance so that you can save on legal costs.
- You can be flexible – Hiring an independent contractor is a great way to get the extra help you need without committing long-term. A project or two, maybe even just one! You can hire them as your budget allows, and this provides more flexibility when company priorities change.
- Expertise when you need it – One of the most appealing advantages of using an independent contractor is that they are experts in a particular area. If you need help with your website design, for example, or if you have more complex requirements such as apps and programming needs – then it would be wise to look outside your company’s usual talent pool.
There are many considerations when it comes to choosing a 1099 or W2 worker. In the end, the choice is yours and should be weighed out carefully based on your budget, type of work or products desired, and how much control you want over the process.
When it comes to the quality of your products, many employers will choose an independent contractor over a W-2 worker. But some disadvantages come with using a contract worker: you give up control over how they do their work and who does what and when on behalf of your company. So if you’re running a tight ship or require specialized skills in-house, then hiring a full-time worker can be more appropriate for this case.
Still Deciding on 1099 or W-2 Employees? Here’s Some Extra Advice on Staffing Your Business
How do you know if your company is ready to hire a 1099 or W2 worker? Two alternatives combine some elements of both—temp agencies and professional employer organizations. Both give access to qualified workers, but they won’t need to be classified as either 1099s or W2 employees.
Considering a Temp Agency
Some businesses are looking for long-term employees but prefer to try them out before bringing them in fully. Hiring from a term agency would be perfect for this type of scenario.
The benefits of using a temp agency are numerous. They take care of recruiting, interviews, background checks, and timely payroll processing so you can focus on other aspects of your business with an additional hand around when needed. The invoices for employee wages and tax forms are taken care of by the temporary agencies to ensure that all tax filings are done appropriately; this saves time and money! You will also be relieved from having to worry about worker’s compensation insurance or human resource issues because these tasks have been delegated as well.
You get to decide how long the worker will work at your company and specify their day-to-day tasks, but you do not technically employ them.
The benefits of hiring a temp instead of administering your own seasonal or temporary-to-hire workforce are plentiful and could save you time. But do not be fooled into believing that this is the way out of being held legally responsible for workplace accidents, which can happen even if the worker isn’t technically considered an employer’s direct employee.
Using a PEO (Professional Employer Organization)
A professional employer organization is a long-term solution to help with short-term employee challenges. They have the ability to outsource HR tasks such as payroll, filling out tax forms, and worker’s compensation while maintaining control of day-to-day responsibilities for employees themselves.
PEOs can use their many employees to negotiate better benefits than small businesses. As with temp agencies, they charge a fee for the service, but it might be worth it due to what you get out of your PEO.
When you sign on with the PEO, they’ll be your go-to for anything administrative or HR-related. Managing and directing the worker’s daily activities falls on the business. You will work together to create a written arrangement outlining how responsibilities should be shared between both parties.
Choosing whether to hire a temporary agency or PEO can be an overwhelming decision. It is important that you do your research and ask for references from both sources before making any decisions.
There could be some potential risks that come with using temp agencies or PEOs, so make sure to consult an attorney before signing. This is the best way to avoid surprises and protect your business interests.
1099 vs. W2 Employee: Making the Right Choice
There’s no magic formula for weighing the pros and cons of hiring a contractor vs. an employee, and it’s no easy task. Still, it’s important to make sure you have all the information you need and your bases covered before making this decision.
Consider what type of work needs to be done for your company, how quickly that job will need to be completed, whether or not the position requires ongoing work, and any regulatory issues at stake (such as with healthcare), etc.
The best thing to do is to get opinions and information by consulting a tax professional along with an employment attorney before making any final decisions about your company’s workforce; at least then, you’ll get expert advice and know exactly which direction is right for you!
United Capital Source has been helping small business owners find the working capital they need to grow their businesses since 2011. Your business is our only business!