1099 vs W2 – which is the winner? Well, it’s not really a matter of which is better, but rather, which fits your business’s needs more.
When it comes to certain positions in your business, the question of hiring an independent contractor vs employee can really make you pause.
Here, we’ll give you a detailed breakdown of what a 1099 employee is, how it differs from a W2 employee, and why those differences matter to your business.
Difference between 1099 vs W2 employees
1099 and W2s are different tax forms that your business is required to send to different workers depending on their employment status. Learning and understanding the differences between 1099 and W2 employees is critical to your business’s legal standing.
If your business misclassifies a W2 employee as a 1099 worker, you may be subject to legal penalties that can run your business a pretty penny. Plus, a W2 employee that’s misclassified by your business can sue your business over the worker benefits that they were denied through that misclassification.
The bottom line: Having a firm grasp over the differences between 1099 and W2 employees is a vital step that every business owner should take in preparation for filing taxes.
What is a 1099 employee?
A 1099 employee is technically not an employee, but rather, they’re an independent contractor. 1099 workers – also referred to as freelancers, contractors, or self-employed individuals – are business owners themselves. That means that they are responsible for paying their own self-employment taxes and that your business is not required to pay a 1099 worker a minimum wage or offer them any other employee benefits.
By January 31st of each year, you’ll need to provide your 1099 independent contractors with a 1099 form, which they’ll then use to file their taxes.
If you are a 1099 employee yourself, you’ll need to keep a much closer eye on your budgeting since you’ll be responsible for paying your own taxes. That typically means paying quarterly estimated tax payments in order to avoid having to shell out a huge amount when tax season comes around. You may even want to consider business loans as a way to give your business the financial cushion it needs to run comfortably. It’s especially important since a self-employed individual’s income can be somewhat inconsistent throughout the year.
All of that information is relevant and useful to know – but what does it really boil down to? Here’s what the IRS says on the matter:
“The general rule is that an individual is an independent contractor if the payer [employer] has the right to control or direct only the result of the work and not what will be done and how it will be done.”
The bottom line: If your employee pays their own taxes and has the legal right to control or direct the result of their work, then they should be regarded as a 1099 employee.
One more important note is that if you want to apply for a PPP loan as a 1099 worker, or as a business that hires 1099 employees, you’ll need to review the specific application instructions since they do differ from more general PPP application guidelines.
What is a W2 employee?
A W2 employee is a regular staff employee who’s entitled to minimum wage, overtime protections, retirement contributions, and other employee benefits.
By January 31st of each year, your business will need to send your W2 employees a W2 form which shows their annual wages. They’ll then use that form to file their taxes. A W2 form also shows any deductions that your business has made from that employee’s paychecks throughout the year.
If you’re not certain whether an employee of yours should be filed as a 1099 vs W2 employee, refer back to the IRS definition:
“You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.”
The bottom line: If you, the business owner, have legal control over the details of how your worker’s services are performed, they should be regarded as a W2 employee.
What’s the difference between a 1099 and a W2 employee?
The key differences between a 1099 vs W2 employee can be summarized in a few points:
- 1099 employees keep track of and pay their own taxes; W2 employees have their taxes withheld by their employers
- 1099 employees get to control and direct the result of their work; W2 employees work according to the employer’s needs and schedule
- 1099 employees don’t get employee benefits unless specified in the contract; W2 employees are entitled to a variety of employee benefits
- 1099 employees are hired for short-term jobs and may have multiple employers; W2 employees are hired for a specific full-time position by one employer
- 1099 employees must provide their own tools and supplies to complete the job; W2 employees are provided with all necessary tools and supplies by the employer
As important as those differences are, the act of determining whether you have a 1099 employee or a W2 employee is a bit more complex than just checking off the points above. Keep reading to find out how to distinguish an independent contractor vs an employee.
How to determine if an employee is 1099 vs W2?
The IRS provides businesses with guidelines on how they should assess the degree of control and independence that employees have in order to designate them as either 1099 workers or W2 employees. By using the following three Common Law Rules, or categories of evidence, businesses can clarify how to define their employees.
The three categories that employers use to determine 1099 vs W2 employee are:
Do you, the employer, have the right to control what your worker does and how your worker does their job?
Employers have control over the services that W2 employees perform, while 1099 workers have more independence and can decide what is done and how it gets done. Employers of independent contractors only have control over what the end result of the work should be.
Do you, the employer, control the business aspects of your worker’s job?
“Aspects of your worker’s job” refers to things like how your worker is paid [hourly, daily, per job, etc.], whether you reimburse your worker for expenses, whether you provide your worker with tools & supplies, etc.).
W2 employees are obligated to abide by the company’s schedule and typically work shifts. They also generally get reimbursed for work-related expenses like traveling, and usually are provided with all necessary tools and business equipment to perform their services.
1099 workers, on the other hand, generally do not work according to strict shifts. They also don’t normally get reimbursed for additional expenses that pop up in throughout their work, and usually have to provide their own tools and equipment to do the job.
3. Type of Relationship
Do you have written contracts with your worker? Do you provide employee type benefits (for example a pension plan, insurance, vacation pay, etc.)? Is the relationship ongoing? Does the worker perform a key role in the business?
W2 employees typically have written contracts that obligate them to certain responsibilities and also provide them with the right to employee benefits. They also have ongoing relationships with their employers and serve an essential role in the business’s everyday functioning.
1099 workers may or may not have a written contract with their employer. Their relationship can be ongoing in the sense that they can be rehired to do several jobs, but in a technical sense, the relationship is limited to the specific assignment that the contractor is there to complete.
Together, these factors are weighed and used to determine whether you’ve hired an independent contractor vs employee. As the IRS puts it, there’s no magic formula that will easily identify a 1099 vs W2 employee – each of the three categories must be considered in their relationship to one another when making this determination.
Which is preferable for your business, 1099 or W2?
Providing an overview of the pros and cons of both 1099 and W2 can get quite detailed. Not only does it require that we also consider the perspective of the employer vs employee, but also the type of business, and even specific job that the employee is there to fill.
Under certain circumstances, it might be better for an employer to hire a 1099 worker, while in other contexts it would make more sense to hire a W2 employee. Likewise, workers stand to benefit from providing services as a 1099 worker in some situations, but in others, it could be better to work as a W2 employee.
Here’s a quick look at the pros and cons of 1099 vs W2:
Hiring a 1099 worker
- Expertise – independent contractors are hired for their experience and can be relied on to handle high-priority jobs that aren’t necessary to fill on a normal basis
- Lower expenses – while the rates for independent contractors may be higher, your business can save money by not having to pay employee benefits or for supplies
- Flexibility – since 1099 employees are hired for specific jobs or for specific periods of time, your business will have an easier time hiring or firing them
- Independence – 1099 employees get to decide what they do and how they do it, leaving the employer with few options if they’re unhappy with how the work is getting done
- Legal concerns – the relationship your business has with independent contractors is almost entirely dependent on the contract you both sign, so you’ll need to be draft it carefully otherwise you may end up in breach of contract
- Insurance – if hurt on the job, freelancers may decide to sue you/your business. On the other hand, W2 employees are typically covered by workers compensation meaning they can’t sue for on-the-job injuries
Hiring a W2 employee
- Loyalty – independent contractors, by definition, move from one employer to the next. W2 employees will often feel more connected to their employer and less likely to change jobs so quickly.
- Dedication – independent contractors are obligated to complete a specific job and are not obligated to work according to the employer’s schedule or needs. The opposite is true for W2 employees, meaning they’ll work according to your schedule and can fill several roles.
- Control – W2 workers follow your instructions for what to do and how to do it, giving you control over the finer details of how your business operates. For independent contractors, you’ll only have control over the end result of the work.
- Higher expenses – Not only do you need to pay W2 employees their salary but also their Social Security and Medicare taxes, and potentially employee benefits depending on laws that may apply to your industry and/or area.
- Tools & equipment – You have to provide W2 employees with all of the supplies they’ll need to perform their jobs. Independent contractors provide their own tools and equipment.
- Management – training and managing your W2 employees is an ongoing part of having permanent staff. This can absorb a significant amount of time and energy – something to take into careful consideration.
With these pros and cons in mind, you’ll now need to consider how they fit with your particular business as well as the role you’re seeking to fill.
For example, if you own a restaurant, nearly all of the employees you hire will be W2 employees. Cooks, servers, bus staff, hosts, managers, and so on – all of those staff members would be permanent employees of the business.
But, there will be situations where your restaurant would need to hire a 1099 worker, like if there’s a plumbing issue or if a large kitchen appliance stops working. But those workers would be brought in to take care of those specific jobs and would not remain a permanent employee after the completion of those projects.
The ratio of 1099 vs W2 employees will differ from one industry to the next and there’s no real equation to determine the ‘appropriate’ number of 1099 employees to hire. Use your best judgment and, of course, the three Common Law Rules referenced above.
We promised you we’d deliver a full breakdown of 1099 vs W2 and independent contractor vs employee, and there you have it, folks! You got a detailed look at what a 1099 employee is, how it differs from a W2 employee, and why knowing those differences matters to the health of your business.
Remember, there’s no one-size-fits-all answer to the question of which is better between 1099 and W2 employees. The answer will depend on several factors that you’ll need to take into careful consideration. Still uncertain? Save this page for you to come back and review later on!