Leaders of smaller, younger businesses typically wear multiple hats. In addition to their company’s customer service representative and marketing director, they are also the human resources manager. It’s up to the business owner to decide which types of employees to hire, based on the company’s limited budget. One major factor that goes into these decisions is whether it makes more sense to hire a 1099 or W2 employee.
The former option is often much cheaper and puts less legal obligations on the employer. This is just one of many differences between the two types of employees. And like other important business decisions, the cheaper option isn’t always best.
In this guide, we’ll explain the differences between 1099 and W2 employees as well as which positions suit each type of employee.
1099 workers are also known as independent contractors because they are technically self-employed. The name “1099” comes from the form they receive from their employer to report income on their personal tax returns. Tax deductions do not come out of the employee’s paycheck, which saves the employer from having to pay payroll taxes. 1099 workers must therefore put money away and pay taxes themselves.
The lack of deductions makes 1099 workers ineligible for employee health insurance as well as other fringe benefits like retirement plans. In most cases, employers enlist independent contractors to work for a defined period of time. That time frame, along with several other conditions, makes up the employee’s contract, hence the name “contractor.”
This includes the conditions for termination. Since independent contractors usually fulfill specific tasks, the only grounds for termination are failing to fulfill their outlined obligations.
Independent contractors can work on one or multiple projects at a time. Some of them continuously work for the same or a select few employers because they have a mutual arrangement that both parties enjoy. The employer can renew the employee’s contract as many times as he or she likes.
Common examples of independent contractors are freelancers who are not sole proprietors. To clarify, that basically means any freelance copywriter, graphic designer, consultant, etc. who doesn’t have his or her own business.
A W2 employee is the typical employee when it comes to salary, taxes, and benefits. While 1099 workers are technically self-employed, W2 employees work for your company and are therefore eligible for employee benefits. Most individuals who work for companies are W2 employees.
Payroll taxes are deducted from W2 employee paychecks, which is just one reason W2 employees are the more expensive option. Employers must also supply required equipment for W2 employees, whereas independent contractors must supply their own equipment. When a W2 employee acquires a work-related expense, he or she is usually reimbursed by the employer. Since independent contractors are their own bosses, their employers usually do not reimburse them for business expenses, though the terms of their contract can say otherwise.
Unlike independent contractors, W2 employees can be fired for virtually any work-related, non-discriminatory reason. An employer can fire a W2 employee even if he or she is performing well.
You’ve just hired a new employee or have finished assembling your initial team. It’s now up to you to decide whether your employees are independent contractors or W2 employees. For many business owners, this is not a simple decision. The line between the two options can get blurry very easily.
But it is an extremely important decision, as the penalties for misclassifying workers can be quite serious. Let’s say the IRS finds out that someone who should have been classified as a W2 employee was instead classified as an independent contractor. You’d have to pay a portion of the income taxes that should have been deducted from the worker’s paychecks, in addition to interest, penalties, and your share of FICA and unemployment taxes. If the IRS deems your misclassification as “willful,” you’d have to pay the full amount of the unpaid income taxes.
To help employers classify employees correctly, the IRS lists three main factors to consider:
If you’re still not sure whether an employee is 1099 or W2, you can file a Form SS-8 with the IRS. The IRS will then consider the circumstances of the position and make a conclusion for classification. It can take at least six months for the IRS to issue their decision, but the form is highly recommended for employers who plan on hiring more individuals for the same unclassified position. The sooner you file the form, the sooner you can hire more employees.
The various differences between the two types of employees makes it easier deduce each option’s pros and cons. In this section, we’ll go over the biggest advantages and disadvantages of independent contractors and W2 employees.
Sometimes, a certain aspect of the position you are looking to fill makes it very easy to decide between an independent contractor or W2 employee. Here are a few scenarios in which the nature of the position clearly requires one option over the other:
As you can see, independent contractors are often the better choice when the job is less conventional. W2 employees are the better choice when you need help with ongoing, time-consuming tasks. Knowing when to choose either option will take a lot of stress off your shoulders because amid your many other cash flow issues, at least you can say you aren’t overpaying for labor.
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