Do you know which you should choose, W2 vs. 1099?
Employee vs independent contractor? Does just thinking about the choice make your head spin? Don’t worry, we’ve got you covered.
In some ways, business was easier when it was just you.
Growth is a good thing and it means your business is going places.
However, there are a lot of technical and administrative headaches you have to deal with along the way. One of those things is figuring out how to categorize the people who are working for you.
It was once much easier to figure this out. Virtually all employees were paid on W2s. Done and done.
But times have changed, and now it’s much more common to hire remote employees and freelancers for various business duties such as marketing, outreach, SEO, and even for basic secretarial jobs such as managing email and creating spreadsheets.
This has made it much harder to know whether those you have working for you should be 1099 independent contractors or more traditional W2 employees.
So, what is the difference? Which type of worker is a better fit for your business? And of those new employees you’re taking on now, how do you know if you should be providing them a 1099/W-9 or a W-2 form?
In this guide, we’ll talk about all of that and more. We’ll be covering:
- What is the difference between a 1099 vs. W2 employee?
- Which is a better fit for your business?
- Pros and cons of both
- How do you know if an employee should be 1099 vs. W2?
- And what forms do you need for each?
Choosing whether to center your business around utilizing independent contractors or traditional employees (or a mix) is an important decision that affects not only your business process but your financial model.
So, it’s important to take the time to consider which is best for you.
What is the difference between a 1099 vs. W2 employee?
To clear up any confusion, the first thing to understand about 1099 vs. W2 is that it’s strictly a matter of tax classification.
In fact, 1099 and W2 refer simply to different tax forms, a 1099 employee being one paid on 1099 (typically, a 1099-MISC form) and a W2 employee one which is paid on a W2.
However, what makes an employee 1099 or W2 is what is important. And that’s what we’ll be talking about in this section.
Not only because each type of worker operates differently, and that affects your business in several ways, but also because failing to classify your employees correctly can lead to tax fines and other fees.
Let’s start with breaking down the basic differences between a worker or employee on 1099 vs. one which should be paid on W2.
What is a 1099 worker?
Technically, a 1099 employee isn’t an employee at all, but an independent contractor. A 1099 worker typically provides a service to your company in exchange for payment.
The most commonly seen 1099 worker is likely your typical accountant.
Accountants sometimes work for a single client, but often they have several different clients. They either spend only a portion of their week in the office of each client– handling payroll, etc.– or work from their own office full-time depending on what they’re hired to do.
This is by no means the only example of a 1099 contractor, though. A freelance webmaster could also perform work for you on a contract, for example.
Independent contractors tend to be hired for a specific period of time to do a particular job. However, as we just talked about in the case of an accountant or webmaster, that’s not necessarily the case.
Because independent contractors are independent, they may also have their own team who help them complete whatever job they’re hired to help you with.
Defining characteristics of a 1099 worker:
- A 1099 independent contractor controls how the work will be done. If you as the employer controls not only the result but also what will be done and how, that worker is an employee.
- A 1099 independent contractor pays all their own taxes, including self-employment taxes. You’re not responsible for paying taxes with 1099 contractors.
- A 1099 independent contractor can’t work a traditional 9-5 shift. They also often complete their work in their own place of business (i.e. remotely).
- A 1099 independent contractor is not eligible for employer benefits. Just as 1099 contractors pay their own taxes as self-employed people, they also must pay for their own employer benefits as business owners.
What is a W2 employee?
A W2 worker is the traditional employee you typically think of in the case of any business.
A W2 worker is a salaried employee who collects employer benefits such as health insurance and retirement and works a typical 9-5 shift. They work for your company and are given a wage dictated by you (in accordance with your state’s minimum wage laws).
Unlike 1099 contractors, you’re responsible as an employer to withhold your W2 worker’s state and federal employer taxes, Medicare, and Social Security.
You’re also responsible for providing them the supplies they’ll need to do their job, be it office supplies, equipment, or various tools.
In the case of a 1099 contractor, the work they do for you is decided based on a contractor and you, having signed that contract, must work with that contractor based on that agreement.
However, in the case of a W2 worker, it is your right to let go of any employee based on any one of several valid reasons such as performance, fraud, or a failure to appear.
Defining characteristics of a W2 employee:
- A W2 employee is a salaried employee who works for you. You dictate not only the results of their work but how they perform that work.
- A W2 employee has all their tax payments withheld by their employer. You as their employer withhold Medicare, Social Security, and state and federal employment taxes.
- A W2 employee can be let go for poor performance or other reasons. They do not work and collect payment based on a contractor like 1099 workers but are employed by your company and can be let go for valid reasons.
1099 vs. W2: Which is a better fit for your business?
Now that you understand clearly the difference between a 1099 independent contractor and a W2 employee, it’s time to start thinking about which is a better fit for your business.
More than ever, many types of businesses are operating entirely online.
In that case, it may make sense to utilize mostly 1099 workers on a regular basis while others for specific projects and only have a few regular employees (if any). That way, you save on taxes, supplies, and office space
However, your business may require more direct communication, retail space, or something else that is more conducive to typical on-location W2 employees, so what is best for you depends on several factors.
Here are the pros and cons of 1099 and W2 employees:
1099 Pros and cons
The primary benefit of 1099 workers is their reduced cost, but there are downsides to independent contractors as well.
Let’s look more closely at the pros and cons of 1099 independent contractors:
1099 Pros
- You don’t have to pay unemployment insurance: Because 1099 workers aren’t employed by you, if you “fire” an independent contractor, they can’t collect unemployment. This is a big expense as it typically amounts to 10% of an employee’s salary. However, keep in mind that there is a caveat to this if you have a mix of W2 and 1099: in many states, such as California, if you have a single ex-employee on unemployment you have to pay the full unemployment insurance amount.
- You don’t have to pay income or payroll taxes on behalf of your 1099 workers: You’re not responsible for paying taxes on behalf of 1099 contractors, including state, federal, Medicare, Social Security, or payroll taxes.
- A 1099 independent contractor doesn’t get employer benefits. Just as 1099 contractors pay their own taxes as self-employed people, they also must pay for their own benefits as business owners, meaning savings for you.
- Easier to hire specialized expertise for a limited period of time: Sometimes, you need a task done for a specific period of time or a single project, so you don’t need another full-time employee. An independent contractor is designed for this, as you can make a contract for one, they complete the work, and then you’re done, helping you save more time and money while getting someone that likely has more experience with the task as well.
- Reduced legal risk: Because independent contractors are not true employees, they don’t qualify for workers compensation and can’t file a wrongful termination claim in most cases.
1099 Cons
- They’re less committed and less familiar with your company: There’s a special kind of dependability that you get with W2 employees that you often don’t get with independent contractors. After all, they don’t work in the office throughout each day and aren’t entrenched in the daily goings-on of the business.
- They’re specialized: As we talked about, an independent contractor is likely an expert in their field, but that’s all they offer. A 1099 contractor can’t and likely won’t shift gears for you because they only offer whatever their services are.
W2 Pros and cons
Like 1099 independent contractors, W2 employees also have their unique pros and cons. Here are the most notable:
W2 Pros
- They’re more dependable, being on-location “9-5”: Your business hours may be different from the typical 9-5, but the point still stands– W2 employees are more dependable because they’re in the office all the time. Independent contractors can, at times and depending on the person, be hard to get a hold of when you need them. They’re also less familiar with your business and brand.
- They’re more committed: W2 employees don’t consider you a “client” of theirs like independent contractors typically do. You’re their employee, typically their only employee, so they’re much more committed to you than a 1099 worker will typically be to your company.
- They can shift gears and help take duties off your back: Independent contractors are designed to offer their specific services and that’s it. However, a long-term employee can be trained to take on many different roles and duties over time, even helping take certain things off your back over time as well.
W2 Cons
- W2 employees cost more than independent contractors: In exchange for the dependability, commitment, and familiarity you get with in-office employees, they do typically cost more. With W2 employees, you need to pay income taxes, unemployment insurance, and benefits among other things.
- They’re typically less specialized, therefore not as well suited for certain tasks: W2 employees aren’t typically specialists. This isn’t always the case, but independent contractors are often experts in their field, so they may be better suited for certain tasks.
When to choose W2 vs. 1099?
There’s a lot that goes into choosing between W2 employees vs. 1099 contractors (and when, because every job your business needs done is different).
For that reason, it may not yet be clear which you should choose for a certain situation.
As you can tell from the pros and cons above, it all depends on what you need.
If you own a tech company and want to be able to handle more clients, you’ll probably need a W2 employee who can work with you to split appointments and complete jobs.
A retail business is the same deal, you need people that are there from open to close to help you run the business.
However, if what you need is someone who is an expert to complete a big job, such as setting up a server in your office, market your service online, or complete your bi-weekly payroll, a 1099 independent contractor might be a better fit.
These are just a few examples, but hopefully, they paint a clearer picture of the kind of situations where you would choose one vs. the other.
Sometimes, you’ll want someone on W2 to help you handle the daily workload and take on some of the tasks you have to do in the shop each day. Other times, you might need someone to help fix up the storefront, ideal for a 1099 contractor.
How do you know if an employee should be 1099 vs. W2 ?
What if you already have an employee, someone new, whom you’ve hired to handle certain things around the business, and you aren’t yet sure what they classify as?
It’s important to know how to classify someone doing work for your business. To wrongly classify an employee who should be W2 as 1099 (perhaps in an effort to avoid paying for insurance or taxes) could mean steep fines and penalties from the IRS, so you don’t want to mess around.
So, 1099 vs. W2 , which is better for your new employee? Let’s look at what Uncle Sam says on the matter.
According to the IRS, there are two points for you as a business owner to keep in mind when figuring out how to classify your workers:
Control. The relationship between a worker and a business is important. If the business controls what work is accomplished and directs how it is done, it exerts behavioral control. If the business directs or controls financial and certain relevant aspects of a worker’s job, it exercises financial control. This includes:
- The extent of the worker’s investment in the facilities or tools used in performing services
- The extent to which the worker makes his or her services available to the relevant market
- How the business pays the worker, and
- The extent to which the worker can realize a profit or incur a loss
Relationship. How the employer and worker perceive their relationship is also important for determining worker status. Key topics to think about include:
- Written contracts describing the relationship the parties intended to create
- Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation or sick pay
- The permanency of the relationship, and
- The extent to which services performed by the worker are a key aspect of the regular business of the company
- The extent to which the worker has unreimbursed business expenses
Ultimately, it comes down to how much control you have over the work and the way in which you work (the working relationship). With these IRS-suggested pointers, it becomes much clearer how to classify a worker as either a 1099 vs. W2 employee.
Still stumped? Fortunately, The IRS has a handy resource, Form SS-8, which you can fill out and send to the IRS to find out exactly how the IRS would classify that worker.
1099 or W2 employee: What forms do you need?
Now that you’re clear on the difference between employees working on W2 vs. 1099 independent contractors, let’s take a moment to dive into their respective tax forms: the W-2 and W-9 (the latter for 1099s).
Form W-9 (for 1099)
The W-9 form is provided to independent contractors who have completed work for you in the previous tax year:
Keep in mind, in the case of 1099 workers only, you or your accountant is required to mail a copy of that worker’s 1099 form at the end of the year which shows the worker’s income for the year.
For more information on the W-9 form, see irs.gov/forms-pubs/about-form-w-9.
Form W-2
Form W-2, as the name suggests, is for W2 employees who work either part or full-time at your business:
The form is a bit simpler than the W-9 and one which most are much more familiar with given that any typical job provides you with this at the end of the year, as opposed to the W-9.
How do you know if you need to provide a W-2 to an employee?
According to the IRS, “Every employer engaged in a trade or business who pays remuneration, including non-cash payments of $600 or more for the year (all amounts if any income, social security, or Medicare tax was withheld) for services performed by an employee must file a Form W-2 for each employee (even if the employee is related to the employer) from whom:
- Income, social security, or Medicare tax was withheld.
- Income tax would have been withheld if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4, Employee’s Withholding Allowance Certificate.”
For more information on the W-2 form, see irs.gov/forms-pubs/about-form-w-2.
Is W2 or 1099 a better fit for your business?
Choosing between hiring someone as a traditional W2 employee vs. 1099 independent contractor may or may not be an easy decision. But it’s always an important one and a decision that’s within your control to make.
How you choose to hire the team that works with you to build your business will affect many important aspects of your business, so take the time to make sure you’re making the choice that best fits you in every position.
You might find that you need a small office staff to answer customer communications or develop your product that are employed on W2 while you can hire several independent contractors outside the office for everything from marketing to accounting.
Ultimately, the choice is yours. Weight the facts of each and remember that you can choose which positions are traditional W2 employees and which are better suited as 1099 workers.
