W-2 Vs 1099 Workers: Understand the Difference Before you Hire
When you’re staffing your business, you have different options for bringing on talent. The two most common types of work arrangements are the use of W-2 employees or 1099 contractors. While there are some similarities between them, there are also key differences that can affect your business so it’s important to understand what’s best for you.
At Complete Payroll Solutions, our HR team helps thousands of companies with employee management. And one of the biggest requests we get is to help businesses understand the pros and cons of W-2 and 1099 workers for certain positions as well as the differences between them. And the distinction is critical since misclassification can lead to liabilities for unpaid payroll taxes, fines, and penalties. Plus, there may be consequences for violating state law as well depending on where you’re located.
Since many employers – inadvertently or not – misclassify workers as 1099 contractors instead of W-2 employees, this article will give you advice on navigating the two arrangements so you can understand the differences between them, what type of worker makes the most sense for your business, and how to make sure your categorization is right. We’ll break down the difference between W-2 and 1099 workers in several areas:
- The amount of control you have over their work
- How their duties compare
- The expenses you’ll incur
- What payroll taxes you’ll have to pay
- Benefits they’re entitled to
- Their impact on culture
What is a W-2 Employee?
When you hire an employee, whether it’s part-time or full-time, the reason they’re referred to as W-2 workers is that you’ll report their wages and all compensation for the year using a Form W-2. The W-2 will also show the withholdings you made from the employee’s pay. Your employees will then use this form to report their income on their taxes.
What is a 1099 Worker?
With an independent contractor, you’ll report their compensation on a Form 1099-MISC as long as you paid them at least $600 for services they performed. Keep in mind that there are different terms to refer to 1099 workers like self-employed individuals, freelancers, or gig workers. These workers are business owners themselves who provide set services to your company and are not on your payroll like a company employee.
The Amount of Control You Have Over a W2 Vs 1099 Worker
The biggest distinction between W-2 and 1099 workers is the amount of control you have over them. With a W-2 employee, you have the right to direct the work being performed. That means giving instruction and providing the tools, training, and equipment to complete the work. You also set their hours and schedules.
Conversely, according to the IRS’s fact sheet on employee vs contractor designations, the general rule is that a worker is an independent contractor if you have the right to control only the result of the work, not what will be done, how or when. As a result, 1099 contractors use their own methods and tools for completing work. Even though they may work for a specific project or period, they do it on their own schedule. And they can provide similar services to other businesses and can accept or turn down work opportunities as they wish.
Since the correct classification of workers is so important, the IRS provides guidelines for assessing the amount of control you have to help you determine if they’re an employee or contractor:
- Behavioral Control: Do you have the right to control what the worker does and how? If so, they’re likely an employee. If, on the other hand, the worker has freedom and discretion in performing the work, they’re probably a contractor.
- Financial Control: Do you control the business aspects of the worker’s job, like how they’re paid and whether expenses are reimbursed? If the answer’s yes, they are more likely an employee. But if the worker incurs their own expenses, that points more to a contractor arrangement.
- Relationship: Does your company have an ongoing relationship with the worker and are there benefits? If you answer yes to this, then you probably have an employee. Ditto if the work performed is a key aspect of your business.
For further guidance, you can also ask the IRS to make a determination for you by filing a Form SS-8.
How a W2 Vs 1099 Worker’s Duties Compare
With W-2 employees, you control what they work on. This means you have oversight over how the work gets done how and when. Part of managing their work also means you can assign a wide variety of tasks to workers. Just think of a typical job description and how many responsibilities are typically listed. This flexibility enables you to focus employees in areas or on projects where they’re needed most.
1099 workers are hired to get a specific job done and can use their own discretion to do so. The good news is that this can free you up from managing their time. But since you hire contractors for specific services that you’ve agreed upon, you don’t have the luxury of being able to task them other duties without changing the scope of your agreement. They also generally set their own hours and deadlines for completing the work. This could lead to a little less reliability, especially if they have other clients they’re working for that may impact their schedules and delivery dates.
The Costs of W2 Vs 1099 Workers
With W-2 employees, you may end up paying less per hour for the same work than an independent contractor. But there are other costs. You’re responsible for managing payroll and required tax payments and contributions for your employees, including your share of Social Security and Medicare as well as state unemployment compensation insurance and workers’ comp. You’ll also have to factor in the cost of any benefits you offer your employees, equipment, and office space. And there’s the ongoing challenge of managing and motivating employees, which can take a lot of time and resources.
With 1099 contractors, you avoid most of these expenses, which is why savings are estimated to be between 20 and 30 percent when using an independent contractor. Not only can it be less costly upfront to hire a 1099 worker, but contractors can also save you money in other ways. For example:
- You won’t have to pay out unused vacation and other expenses when they leave the job
- Since many 1099 workers specialize, you may be able to spend less on training – although when they leave, they’ll take their skills with them
- Because contractors are not subject to the same protections under the law, you may avoid legal expenses arising from claims against you
- You won’t have to pay for gas, tools, or supplies
Payroll Taxes for W2 Vs 1099 Workers
When it comes to payroll taxes, these are automatically deducted from a W-2 employee’s paycheck. You as the employer withhold income taxes and pay Social Security, Medicare taxes, and unemployment tax on wages paid. At tax time, as discussed earlier, you’ll need to give employees a W-2 that shows the amount of these taxes that were withheld from their pay.
For independent contractors, you’ll need to issue a Form 1099-MISC to report what you paid if they received $600 or more during the year. Those working as contractors will use these 1099s to total their net earnings and calculate their self-employment tax, which they’ll have to submit directly to the IRS. The self-employment tax is 15.3% — double what a W-2 employee pays since employers pay half the payroll taxes. However, when it comes to taxes, the one upside for 1099 workers is that most of their expenses they incur to complete their work can be deducted.
W2 Vs 1099 Worker Benefits
W-2 employees are afforded protections under the law, such as minimum wage, overtime, and family and medical leave. They’re also entitled to participate in your benefits like health and dental insurance, which are often better than what they can afford on their own. If you offer a competitive package, it can go a long way towards making employees feel valued, which can improve performance and productivity. But as you know, benefits can be costly. In March 2020, the Bureau of Labor Statistics found that benefit costs accounted for 29.8 percent of wages and salaries for workers in private industry.
With 1099 workers, you don’t have to worry about offering them employer-sponsored benefits. Independent contractors are also not covered by workers’ comp and unemployment insurance, saving you on these expenses as well.
The Impact of W2 Vs 1099 Workers on Culture
With W-2 workers, you’re able to bring employees on board who are a good fit within your organization and reflect your values. These workers become part of your team and workplace environment and contribute to a better company’s culture, which can help with retention as well as recruitment. Employees may also feel more secure in their roles, which can contribute to increased focus since they won’t always be looking to line up the next job.
Typically, 1099 contractors aren’t as invested in the company culture. That’s because they generally complete a job or assignment, then move on to the next. And that can be disruptive for other employees and the culture. But the transient nature of 1099 workers can be an advantage since there’s no obligation to continue working with a contractor after their assignment’s done, making it easier to end a relationship than terminating an employee.
Should You Hire a W-2 Employee or 1099 Worker?
Whether you hire workers as employees or enter into contractor relationships, there’s a lot to consider. One or both types can contribute to your organization and help you meet your goals.
A W-2 employee is a good fit if you:
- Want committed workers who will be loyal and productive over the long term
- Prefer to keep worker knowledge and skills in-house
- Have a distinct corporate culture you want to foster and maintain
1099 workers could be right for your business if you:
- Don’t want to have to pay payroll taxes or for benefits to keep your costs low
- Would rather not invest the time or resources in training and prefer to bring in specialized expertise
- Want the flexibility to terminate a relationship when a project is done or as your budget allows
Even if you bring someone on board as a W-2 employee or 1099 contractor, it’s a best practice to reassess their role over time since the relationship may change — and misclassifying your workers has steep financial consequences. For more information on the difference between these types of workers, read our next article.