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1099 vs W-2 Employee: Understanding the Difference

1099 vs W-2 Employee: Understanding the Difference
Ines Zemelman, EA
10 December 2021

An understanding of the difference between workers and independent contractors, also commonly known as 1099 vs W-2 employees, and when to use 1099s and W-2s can be complicated and stressful.

Even if you hire a payroll service or an accountant to handle the heavy lifting of paying your employees, it's critical that you have a firm grasp on how to classify them. The classification of your workers, whether as employees or independent contractors, determines how you and your workers are taxed.

To make an informed decision on which type of worker to hire, you must first be aware of how they differ and why one could be better for your business or specific role than the other. It is imperative that you understand the difference because misclassification of employees can lead to financial fines.

Difference Between 1099 vs W-2 Employee

Payroll taxes are deducted from employees using tax forms 1099 and W-2. 1099 workers are independent contractors. They get compensated and receive 1099 for tax purposes.

A W-2 employee gets a regular wage and benefits. Taxes are deducted from pay, and the employer controls the employee's work.

1099 Worker vs W-2 Employee: What's the Difference?

With that in mind, let's examine the distinctions between an independent contractor 1099 and a W-2 employee. Each of these is referred to as a "Tax Form." Independent contractors are given a Form 1099-MISC by their employers, whereas a W-2 is filed by employers on behalf of their employees.

There are significant contrasts between independent contractors and employees, even though both provide essential services to small firms. To prevent major fines and legal costs for misclassifying your employees as contractors, you must be aware of these distinctions. Employees who are incorrectly classified as independent contractors on their W-2 forms may sue your business to recover wages and benefits they could not receive because they were misclassified as employees.

It is important to go over the key identifiers for both sorts of workers and how to tell them apart to clear up any misunderstandings.

What Is a 1099 Worker?

Independent contractors—or 1099 workers—usually perform a limited set of services, as stipulated under a signed agreement. In some cases, 1099 workers only take on one project at a time. However, in other cases, they provide a service to several clients within their area of competence. Freelancers and consultants are self-employed; thus, they're business owners in their own right.

Most organizations engage W-2 personnel with the purpose of employing them for an indeterminate period of time. Businesses, on the other hand, contract with independent contractors for a specific amount of time, according to the terms of the agreement. A 1099 worker's engagement can be renewed as both parties agree based on mutual advantage.

Independent contractors set their own hours and methods for doing the work you've hired them to do. To help them offer the product or service you hired them to supply, 1099 freelancers can also choose to hire their own personnel. As a result, independent contractors, whether content creators or truck drivers or those who provide services are responsible for all of their own financial outcomes.

As a result of your limited level of control over independent contractors, your level of financial and legal obligation is also low. You don't have to pay payroll taxes if you hire an independent contractor who pays both employee and employer self-employment taxes. Your W-2 employees get health insurance coverage, paid time off, and over time, but 1099 workers do not because they're self-employed.

What Is a W-2 Employee?

W-2 workers are considered salaried employees. A W-2 employee, unlike an independent contractor, is not the proprietor of his or her own company. You hire them, they're covered by your company's benefits, and they work around your business's demands and schedule. The default categorization is W-2 employee unless there is a compelling cause to categorize a worker as an independent contractor.

For as long as they've worked regularly and consistently, employees are entitled to at least the federal and state-mandated minimum wage. W-2 workers' Social Security and Medicare taxes are withheld by employers, while the employer payroll taxes are paid by the company.

To dismiss an employee for underperformance or any other legitimate, non-discriminatory reason is generally permitted by most companies. On the other hand, an independent contractor works and is paid in line with the agreement of a signed contract between the parties involved. Taxes are also paid by them.

W-2 employees get all the tools and supplies they need from their employers. Contractors who work on their own dime are required to do so. It is also common for employers to pay employees for business expenditures they incur while working. Unless explicitly stated otherwise in their contract, independent contractors are not normally subject to this rule.

All employees in a company who qualify can take advantage of various benefits, such as health insurance, retirement contributions, and flexible spending accounts. Benefits are not available to independent contractors who work for a company.

How to Determine Whether Your Employees Are 1099 vs W-2 Employees

It is critical to understand what “1099 vs W-2 employee” means and accurately identify your employees as either a 1099 or W-2 employee with the IRS. When deciding whether to hire a contractor or a full-time employee, cost and convenience are often the most important considerations for a business owner. Paying a contractor rather than administering payroll and other HR duties is a lot easier than doing so for a company with workers.

You may save money and time, but it would become a liability if the IRS or the Department of Labor audit you and discover that you've misclassified staff. Because the IRS is quite strict when it comes to 1099 vs W-2, they can charge fines and back taxes of more than 40% of the contractor's salary. It's possible that the Department of Labor (DOL) could order you to pay wages for the past three years.

Accordingly, the border between 1099 and W-2 workers can be difficult to discern, but the IRS provides helpful advice on the matter. In deciding whether a worker is an employee or an independent contractor, the IRS looks at three main categories:

1. Behavioral

Is your company able to dictate where, when, and how a worker performs their duties?

2. Financial

Who is responsible for the financial aspects of the worker's job? What is the payment method?

3. Nature of Relationship

Are there any benefits you can offer this employee? What are the terms and conditions of this relationship, such as a contract, employment agreement, or other legal documents?

The classification of employees boils down to how much influence a company has over the worker. If the employer controls the majority of the worker's labor, it is likely to be a W-2 employee. If they have a high degree of freedom and autonomy, it is most likely that they are a 1099 independent contractor.

In the event that you're still unsure about the status of a member of your staff, here are three things to keep in mind: Obtain and submit Form SS-8 to the IRS. Your employees may be classed as independent contractors if the IRS rules in your favor. The IRS can take up to six months to make a decision, but this is advantageous if your company frequently hires for the same positions.

1099 Employee vs W-2 Employee: Which Is Better for Your Business?

Now that we have a good understanding of 1099 vs W-2 employees, we can address the issue you've probably been asking yourself: "1099 vs W2: which is better for my employee and my business?"

As a result of the perceived savings, working with independent contractors is a common choice for many small business owners. Employing W-2 workers means incurring expenditures like payroll taxes and worker compensation insurance that may quickly eat away at a company's bottom line if they aren't properly managed. W-2 vs 1099 advantages and disadvantages must be considered in addition to the costs.

Advantages of 1099 Independent Contractors

1. Expertise

Most independent contractors specialize in one area and execute it really well. If you have a project that requires a high level of design or technical expertise, an independent contractor is likely to be able to help.

2. Flexibility

Instead of a long-term employee, you can hire an independent contractor for one or two projects or as your budget permits. When corporate priorities and resources change, this provides you greater flexibility.

3. Less Legal Risks

An independent contractor is not entitled to workers' compensation and cannot sue for wrongful termination. They often have their own professional liability insurance. As a result, the risk to your firm is reduced.

4. Lower Business Costs

You can save money by employing a 1099 worker rather than a W-2 employee. You don't have to pay independent contractors a minimum wage, overtime, or benefits. Using independent contractors reduces your company's administrative load because you don't have to withhold or pay payroll taxes like you do when using employees on a W-2 form.

Advantages of W-2 Employees

1. Commitment to the Company

Treat your staff well, and you'll reap the benefits in the long run. They'll be more inclined to go the additional mile for your organization if they feel like they're doing a good job. Independent contractors can be fantastic, but you're generally only one of many customers.

2. Continuity

Employees are there for the long haul, and they're always ready to provide help whenever your company needs it. Employees can be called upon to help out if the employer needs someone to shift their focus or contribute to a project on short notice.

3. More Free Time for the Business Owner

As a small business owner, you'll wear a lot of hats, and it can feel like you're never getting a break. As a business owner, having workers helps you to delegate long-term tasks so that they're off your plate. In this way, you'll be free to concentrate on higher-level company issues.

4. One-time Training

As part of the initial onboarding process, employees must get training. After that, they should continue to undergo training, but they'll already be familiar with the company's rules and guidelines. Because independent contractors aren't employees, you can't always rely on them to fulfill your high standards of quality.

To sum up

The distinction between workers and independent contractors must be clearly understood by business owners. Wages paid to employees generally necessitate the withholding and payment of income taxes, social security taxes, Medicare taxes, and unemployment taxes. Paying independent contractors does not require you to withhold or pay taxes.

Consider a few factors before making a final selection. These factors include how quickly you need a job to be completed, what kind of work you need to be done, whether the job is one-time or regular, and the costs associated with hiring 1099 or W-2 employees.

An employment lawyer and tax expert should be consulted before you make your final decision.

Ines Zemelman, EA
Founder of TFX