The Differences Between 1099 and W2 Employees

The IRS is currently understaffed, and companies are left to choose between the two forms of taxation. While 1099 employees lose out on tax-free income, W2 employees don’t have a similar loss in benefits. What form should your company be using?

When it comes to recruiting new personnel, company owners have the option of using independent contractors or employing full-time employees. Contractors have greater freedom in how they carry out their tasks, but they are not covered by labor rules like minimum pay. Because their employers do not withhold taxes from their pay, they also get separate tax forms (1099 versus W2) to report their earnings to the IRS.

Misclassifying workers as contractors may result in thousands of dollars in taxes and penalties due to variances in payroll tax treatment. We’ll walk you through the distinctions so you can determine which kind is best for your company as an employer.

The Differences Between 1099 and W2 Employees

As a firm grows, many companies must decide whether to recruit full-time (or part-time) workers or independent contractors. There are many reasons why you should choose one over the other, but first, let’s go through the key distinctions between a W2 employee and a 1099 contractor.

1. Wage and Salary Taxes

When you recruit workers, you’re in charge of payroll, which involves withholding payroll taxes from their paychecks and paying taxes on their profits out of your own assets. When you engage independent contractors, you pay them their whole profits for the term, unlike when you recruit employees. You don’t have to withhold taxes, and your company doesn’t have to pay taxes for hiring them.

To make things easier, pretend you had a $1,200-per-week employee. Because they’re an employee rather than a contractor, their salary will be less than $1,200, so you’ll need to reduce the entire taxes you’re obligated to withhold to figure out how much to pay them. However, if the person worked as an independent contractor, they would be paid the full $1,200. Contractors are solely responsible for settling their tax obligation with the IRS.

W2 vs. 1099 tax forms

Employers handle payroll tax payments for their workers, but employees are responsible for making sure they don’t owe any more taxes (or aren’t owed a refund owing to an overpayment). Employees and contractors, in this sense, share some responsibility for paying any overdue obligations to tax collectors. Employers assist with this by releasing year-end tax forms (1099 and W2) that detail the total amount earned by each employee for the year.

Contractors get Form 1099, which includes the worker’s name, SSN, address, and total wages for the year. Form W2 is sent to employees and contains the same basic information as Form W1, as well as the total taxes and other deductions deducted.

2. Protection under Federal Labor Law

When it comes to federal labor law rights, W2 workers and 1099 contractors are handled differently. US labor laws protect employees from being paid less than the federal minimum wage, which is currently $7.25 per hour, ensure that eligible employees (typically hourly workers) receive overtime for hours worked over 40 in a week, and establish strict guidelines for when minors can work and what kind of work they can do.

Employers may be sued and/or face lawsuits if any HR or payroll compliance requirements are breached. Contractors, on the other hand, are unaware of these safeguards and have little remedy unless it is specifically specified in their contract.

At-Will Employment: Firing Employees vs. Independent Contractors

Another consideration is the At-Will Employment theory, which allows you to fire workers at any time and without reason (as long as you don’t break any federal laws). If you need to terminate a contract, it won’t be as simple; you’ll have to follow the conditions of the contract you signed when you first started working with them.

• You have the right to fire a W2 employee at any moment. It’s advisable to include at-will employment wording in all employment agreements and employee handbooks to protect oneself. However, you must adhere to all federal and state labor regulations, which are intended to set limits for employee dismissal.
• With a 1099, you must pay close attention to the contract’s conditions as well as your ability to cancel it. When bargaining, bear in mind that certain contracts are difficult to break. We suggest that any side provide at least a 5-10 day notice of termination.

3. Salary & Benefits

Finally, one of the most significant distinctions between employees and contractors is the manner in which they are compensated and the benefits to which they are entitled.

• W2 workers might be paid or hourly, full-time or part-time, and have a regular schedule (generally biweekly, semimonthly, or weekly).
• 1099 contractors are less likely to be paid on a regular basis, although you may pay the monthly bills or on a project-by-project basis.
• Employees are entitled to benefits such as health insurance, flexible spending accounts, and so on.

There are more distinctions between employees and contractors, but those are the most important ones to understand before deciding which kind of worker to hire.

Employees vs. Independent Contractors: 1099 or W2?

There are three major considerations to ask yourself when categorizing 1099 versus W2 team members at your company, according to the IRS. It’s worth noting that for a person to be labeled an employee, just ONE of the questions must be answered yes.

1. Behavioral question: Does the firm have the right or authority to govern what the employee does and how he or she performs his or her job? If “yes,” the individual is most likely a W2 employee. The worker is more likely to be a 1099 contractor if they have control over their own schedule and work process.
2. Financial question: Does the employer have control over the commercial parts of the employee’s job? (Things like how a person is compensated, whether expenditures are reimbursed, and who provides tools/supplies are all examples.)They’re probably a W2 employee if the employer controls how they’re paid and pays for their costs and supplies. It’s more probable that the worker is a 1099 contractor if they have to produce an invoice to be paid and/or pay their own expenditures.
3. Is there a documented employment contract (as opposed to a project or an independent contractor arrangement) or employee-type perks (such as health insurance or vacation pay)? Is the job completed an important component of the company, and will the working relationship continue for the foreseeable future if the task is done correctly? If the employer offers benefits and expects the person will stay for a long time, they are most likely a W2 employee.

Employer Benefits of Form 1099

Because 1099 contractors have some benefits over W2 workers, some company owners choose to hire them.

1. Reduced tax bill: When you hire workers, you must not only withhold their taxes, but also pay Social Security, Medicare, and unemployment insurance taxes. This is in addition to the employee’s remuneration. Independent contractors are responsible for paying all of their own taxes.
2. Reduced recruiting costs: Most states mandate that employers purchase workers’ compensation insurance for their employees. When dealing with independent freelancers, this isn’t necessary.
3. Benefits like healthcare, 401(k) plans, and paid time off are expected by many full-time workers. Benefits will not be expected from independent contractors.
4. Reduces the chance of getting sued: Independent contractors are not subject to the same federal labor regulations as employees. All you have to do now is check what you put in their contract and make sure there’s an “out” provision.
5. Many contractors provide experiences in their industry, such as technical recruitment or computer programming in a certain language, and need little to no training. This will save you time when it comes to educating your present personnel to master new abilities.
6. More flexibility: Depending on your arrangement with the independent contractor, you may often utilize them as a “dip in and out” resource as your company demands.

Employer Disadvantages of Form 1099

Employers should be aware of the drawbacks of having a 1099 contractor on staff when making recruiting decisions.

1. Higher hourly rate: A contractor would often charge more per hour than a salaried team member; after all, they must pay taxes out of the money you pay them. You may, however, check into contractors from other nations and newcomers wanting to establish themselves on freelancing services (such as Upwork) in order to save money.
2. Teamwork: Because a contractor is not an in-house employee, he or she may not be the greatest match for your team. You should make sure they grasp the company’s structure and their role early on, as well as develop a communication strategy with them (for instance, scheduling weekly calls or updates).
3. Capacity: If an emergency arises, your contractor is unlikely to work late or into the wee hours of the morning, particularly if they have other customers. An employee will frequently go above and beyond, within reason, to complete the task, even if it means working extra.

Now let’s look at why you would want to hire an employee versus a contractor to work for your company.

Employer Benefits from W2

Posting a job and employing a W2 employee has five significant advantages:

1. Recruitment: You’ll receive a lot more candidates for recruiting reasons, and a larger talent pool will be interested in the position. It’s also far simpler to publish a permanent position on a typical job board, such as Zip Recruiter, than it is to list contract employment.
2. Planning for succession: As your company expands, you’ll need to promote individuals and hire management. Hiring W2 workers makes this more constant, and it enables you to have individuals “on deck” or ready to assist if someone resigns or has to be dismissed abruptly. In most cases, a contractor is unable to assist.
3. Accountability: An employee will understand that their job and maybe perks are contingent on their performance. They are usually held to a higher standard of accountability than a contractor. Keep in mind, however, that there are good contractors and bad workers out there.
4. Employees, on the whole, contribute to a more unified corporate culture. They might wind up becoming great coworkers and long-term employees. Contractors have a tougher time doing this since they are frequently off-site and don’t work predictable hours.

Employer Disadvantages of W2 Workers

The following are the top three drawbacks of recruiting W2 employees:

• 1. Costs of payroll, unemployment, and workers’ compensation: You must pay payroll, unemployment, and workers’ compensation for all employees. This may easily mount up and should be taken into account when calculating the employee’s overall cost to the organization.
  2. Increased chance of litigation: To ensure that you’re terminating someone correctly, make sure you’re using things like performance evaluations and progressive punishment for behavior concerns. Despite the fact that most states are at-will, it is simpler for an employee to sue than it is for a contractor.
  3. More time is required to manage: A W2 employee must be taught, have questions, and be transferred into their new position. It might take 30, 60, 90, or even a year for them to be thoroughly taught. Because these employees are members of your team, you will devote much more time and money to assisting them in being the best they can be than you would a contractor.

Conclusion

Employees and independent contractors may both be important assets to a company since they do tasks that are required to manage it. It’s critical to know the distinctions between the two and analyze your requirements. You should hire an employee if you require a strong feeling of control over the task and/or the worker’s time. Avoid the temptation of labeling an employee as a contractor since it may cost you a lot of money in taxes, particularly if you have to include fines and penalties.

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Frequently Asked Questions

Is it better to have W2 or 1099 employees?

A: It is better to have 1099 employees than W2.

What qualifies as a 1099 employee?

A: A 1099 employee is not only an individual who works for the company in question, but they are also self-employed. The difference between a W-2 Employee and a 1099 Employee comes down to whether or not their pay is taken out of gross income before taxes are applied, or if it’s considered as taxable income first and then withheld by the employer.