Leaders of smaller, younger businesses typically wear multiple hats. In addition to their company’s customer service representative and marketing director, they are also the human resources manager. It’s up to the business owner to decide which types of employees to hire, based on the company’s limited budget. One major factor that goes into these decisions is whether it makes more sense to hire a 1099 or W2 employee.
The former option is often much cheaper and puts less legal obligations on the employer. This is just one of many differences between the two types of employees. And like other important business decisions, the cheaper option isn’t always best.
In this guide, we’ll explain the differences between 1099 and W2 employees as well as which positions suit each type of employee.
What is a 1099 Worker?
1099 workers are also known as independent contractors because they are technically self-employed. The name “1099” comes from the form they receive from their employer to report income on their personal tax returns. Tax deductions do not come out of the employee’s paycheck, which saves the employer from having to pay payroll taxes. 1099 workers must therefore put money away and pay taxes themselves.
The lack of deductions makes 1099 workers ineligible for employee health insurance as well as other fringe benefits like retirement plans. In most cases, employers enlist independent contractors to work for a defined period of time. That time frame, along with several other conditions, makes up the employee’s contract, hence the name “contractor.”
This includes the conditions for termination. Since independent contractors usually fulfill specific tasks, the only grounds for termination are failing to fulfill their outlined obligations.
Independent contractors can work on one or multiple projects at a time. Some of them continuously work for the same or a select few employers because they have a mutual arrangement that both parties enjoy. The employer can renew the employee’s contract as many times as he or she likes.
Common examples of independent contractors are freelancers who are not sole proprietors. To clarify, that basically means any freelance copywriter, graphic designer, consultant, etc. who doesn’t have his or her own business.
What is a W2 Employee?
A W2 employee is the typical employee when it comes to salary, taxes, and benefits. While 1099 workers are technically self-employed, W2 employees work for your company and are therefore eligible for employee benefits. Most individuals who work for companies are W2 employees.
Payroll taxes are deducted from W2 employee paychecks, which is just one reason W2 employees are the more expensive option. Employers must also supply required equipment for W2 employees, whereas independent contractors must supply their own equipment. When a W2 employee acquires a work-related expense, he or she is usually reimbursed by the employer. Since independent contractors are their own bosses, their employers usually do not reimburse them for business expenses, though the terms of their contract can say otherwise.
Unlike independent contractors, W2 employees can be fired for virtually any work-related, non-discriminatory reason. An employer can fire a W2 employee even if he or she is performing well.
Are Your Employees 1099 or W2?
You’ve just hired a new employee or have finished assembling your initial team. It’s now up to you to decide whether your employees are independent contractors or W2 employees. For many business owners, this is not a simple decision. The line between the two options can get blurry very easily.
But it is an extremely important decision, as the penalties for misclassifying workers can be quite serious. Let’s say the IRS finds out that someone who should have been classified as a W2 employee was instead classified as an independent contractor. You’d have to pay a portion of the income taxes that should have been deducted from the worker’s paychecks, in addition to interest, penalties, and your share of FICA and unemployment taxes. If the IRS deems your misclassification as “willful,” you’d have to pay the full amount of the unpaid income taxes.
To help employers classify employees correctly, the IRS lists three main factors to consider:
- Behavioral – Does the employer control when, where and how the employee does their job?
- Financial – Does the employee receive a flat fee or salary? Who pays for tools and other business expenses?
- Type of relationship – Does the employee receive benefits? Are the terms of the relationship outlined in a contract or other form of documentation?
Still Not Sure?
If you’re still not sure whether an employee is 1099 or W2, you can file a Form SS-8 with the IRS. The IRS will then consider the circumstances of the position and make a conclusion for classification. It can take at least six months for the IRS to issue their decision, but the form is highly recommended for employers who plan on hiring more individuals for the same unclassified position. The sooner you file the form, the sooner you can hire more employees.
1099 or W2: Which Does Your Business Need?
The various differences between the two types of employees makes it easier deduce each option’s pros and cons. In this section, we’ll go over the biggest advantages and disadvantages of independent contractors and W2 employees.
1099 Worker Advantages
- Lower Costs – Employers do not have to pay payroll taxes or provide benefits to independent contractors. And since independent contracts are meant to be hired for a specific period of time, you don’t have to worry about paying someone to sit at a desk and do nothing all day. For every minute independent contractors are under your employment, they are actively working and contributing to revenue.
- Experience – Independent contractors usually work on individual projects or a certain type of project. In other words, they are more likely to have extensive experience with specific tasks. So, if you are looking for someone to tackle a specific, relatively advanced project, an independent contractor may be the better choice.
- Flexibility – The relationship between employers and W2 employees does not have a clear time frame. In fact, you technically have no idea how long they will work for you. Independent contractors, on the other hand, can be hired for as long as your budget allows or until a project is finished.
- Less Legal Risk –Independent contractors cannot receive workers’ compensation coverage or other benefits. The terms of the relationship are clearly defined in a contract. The likelihood of a work-related lawsuit, like a wrongful termination claim, is therefore much lower than with a W2 employee.
W2 Employee Advantages
- Work On Your Terms – A big reason W2 employees are more expensive is because you are paying for them to play by your rules. The employer controls when they work, where they work, and how they do their jobs. While independent contractors are only loyal to their contracts, W2 employees are loyal to their employers, in exchange for benefits and a steady paycheck.
- More Flexibility – Independent contractors technically do not have to do any work that isn’t in their contract. W2 employees, on the other hand, gradually take on more work and learn new skills. Though they might not have the expertise of an independent contractor, W2 employees are more willing to put in the extra effort when your company is ready to grow.
- Clearer Picture Of The Future – Once you hire a W2 employee, you don’t have to worry about continuously finding someone else to handle that employee’s responsibilities. That element of your business is permanently under control. This takes stress off the employer and gives him or her more time to concentrate on growing other elements of the business.
- Company Culture – W2 employees work normal business hours in your location, making it possible to train them in company culture and other important policies. Company culture has proven to be essential for growth, but only if employees clearly understand your standards and goals.
Key Factors That Simplify The Decision
Sometimes, a certain aspect of the position you are looking to fill makes it very easy to decide between an independent contractor or W2 employee. Here are a few scenarios in which the nature of the position clearly requires one option over the other:
- Short-Term Projects – If you need help completing a short-term project, an independent contractor is usually the better choice. Independent contractors tend to have significant experience with specific projects and can therefore get the work done at a faster pace.
- Employee Must Be On Location – If the employee must work at your location and on your schedule, a W2 employee is usually the better choice. Independent contractors typically prefer to work remotely and on their own schedule.
- Smaller Amount Of Work – Let’s say the open position requires just a few hours’ worth of work per week. In this case, an independent contractor would be the better choice because there’s not enough work to justify the cost of a W2 employee.
- Job Requires Training – Many companies incorporate systems and methods known only by their team members. In this case, a W2 employee would be the better choice because the job requires exclusive company training.
Conventional vs Unconventional
As you can see, independent contractors are often the better choice when the job is less conventional. W2 employees are the better choice when you need help with ongoing, time-consuming tasks. Knowing when to choose either option will take a lot of stress off your shoulders because amid your many other cash flow issues, at least you can say you aren’t overpaying for labor.