When you’re staffing your business, you have different options for bringing on talent. The two most common types of work arrangements to consider are the use of W-2 vs. 1099 workers. 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 your organization’s hiring needs.
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 a W-2 worker is because 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 a 1099 worker, you’ll report their compensation on a Form 1099-NEC as long as you paid them at least $600 for services they performed. Keep in mind that there are different terms to refer to a 1099 worker like an independent contractor, self-employed individual, freelancer, or gig worker. These workers are business owners themselves who provide set services to your company and are not on your payroll like a company employee.
The biggest distinction between a W-2 employee and 1099 worker 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, 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, that person is likely an employee. If, on the other hand, the worker has freedom and discretion in performing the work, that person is 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, that person is most likely an employee. But if the worker incurs his or her 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 the Duties of a W-2 Employee and a 1099 Worker Compare
With W-2 employees, you control what they work on. This means you have oversight over how the work gets done 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 with 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, potential overtime for those that are non-exempt 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 up to 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-NEC 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 percent — 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 the expenses they incur to complete their work can be deducted.
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.
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 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. 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 is done, making it easier to end a contractor relationship than terminate an employee.
What happens if I misclassify a W-2 employee or 1099 contractor?
It’s crucial to get proper classification right since misclassification can result in steep legal or financial consequences for your business.
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
A 1099 worker 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
- If you’ve identified that bringing on a contractor makes the most sense, it’s important to further understand who a 1099 worker is. In contrast, if you’ve decided a W-2 employee best meets your business’ current needs, you’ll also want to make sure you understand the different types of employees you can hire so you’re staffing your business appropriately.
Karyn H. Rhodes is vice president HR Solutions at Complete Payroll Solutions. She specializes in all areas of human resources, including strategic planning, employee and labor relations, recruiting, compliance, training and development, compensation and benefits, policies and procedures, organizational development, executive coaching, workforce planning, and affirmative action plans. More info at completepayrollsolutions.com