Unless your business is a one-person operation, you’ll need to hire other people to work for you at some point. You can hire full-time or part-time employees, or you can hire contractors instead. While both types of workers can get work done, they are not the same. How you engage them can seriously impact your bottom line, so it’s important to understand the difference between 1099 contractors and W-2 employees.
What are 1099 contractors and W-2 employees?
A 1099 contractor, also called an independent contractor, is self-employed and usually works for multiple companies. They may step in to provide short-term expertise for your business (for example, building your website) or work on longer-term projects (such as a copywriter writing regular marketing content for your company). You don’t provide them with benefits like health insurance or paid vacation, and you typically wouldn’t withhold taxes from their paycheck, either.
On the other hand, a W-2 employee typically works on a longer-term basis with your company. As the employer, you may require them to work set hours and use certain tools for their job. You also may provide benefits and are required to withhold taxes from their paycheck.
When you’re just beginning to hire employees or contractors, it can be difficult to tell how you should classify your workers. The IRS has some clear guidelines to help you tell the difference between independent contractors and W-2 employees.
Three key areas to help you tell the difference
Behavioral: Does the company control what the worker does and how they do their job? This could include controlling when and where the employee works, where they need to purchase supplies, who must do certain types of work, and whether the company provides training.
Financial: Are the business aspects of the worker’s job controlled by the company? This could include whether the worker has unreimbursed expenses (if so, it would point to a contractor) or if they are able to seek work for other businesses. Employees may also have a guaranteed regular wage, whether hourly or salary, while a contractor may be paid a flat fee or hourly for the job.
Type of relationship: Are there written contracts or employee benefits such as insurance and vacation pay? If you hire someone for ongoing work, this can indicate an employee relationship. However, if you hire them for a set project or a specific length of time, this could point to a contractor relationship.
On the surface, it may look like the main difference between 1099 contractors versus employees is how you pay them and whether you withhold taxes. However, there are several other key differences between the two.
Differences in legal status between 1099 Contractors and W-2 Employees
The relationship an employer has with an employee is much different from the relationship they have with contractors. Employers are legally required to give their employees certain rights. These include complying with state or federal laws like minimum wage or overtime pay laws and maintaining worker’s compensation insurance if an employee is injured on the job. There are also additional rules, such as compliance with the Americans with Disabilities Act and requirements for meal breaks.
Large employers with 50 or more employees are subject to even more legal requirements. They must provide health insurance for their employees and comply with the Family and Medical Leave Act, both of which can be major expenses for employers.
Employers who don’t follow these rules could find themselves in legal trouble, opening themselves up to lawsuits for neglecting to provide required benefits. But employees can also sue their employers for other reasons, such as discrimination or wrongful termination.
Contractors aren’t employees, so employers aren’t required to fulfill employee/employer obligations. The relationship is different since the 1099 contractor usually assumes all the risk for their actions and income. The contractor handles their own health and liability insurance and ensures their own breaks or meal times. However, there may still be instances where a contractor can sue a company, such as for breach of contract or nonpayment.
Benefits of hiring 1099 contractors and W-2 employees
Now that you understand the difference between these two types of workers, how can you decide which one you should hire?
Benefits of hiring a 1099 contractor
Working with a 1099 contractor has several benefits as long as the worker qualifies as a 1099 contractor. Hiring 1099 contractors can sometimes be less expensive than hiring employees since you don’t need to onboard them, train them, or purchase tools or equipment for them. You’ll also save money on benefits and taxes.
Contractors can also be an excellent choice if you have a short-term project involving a certain set of skills you don’t already have in-house. Contractors can provide flexible, short-term work without the obligation of hiring and retaining an employee. Their expertise can add value to your projects without you having to train them.
Cons of hiring a 1099 contractor
Using a contractor may mean you have less control over the work than you would like. Contractors may keep their own schedule, and while they should still meet any agreed-upon deadlines, some employers want to be able to closely monitor and direct the work done. If an employer wants to closely monitor and direct the worker, the worker may move into employee status.
If the work is intermittent, you may find a great contractor to complete the initial job but then find they are already booked with other work when you’re ready to hire them again. Quality varies between contractors, so it can be difficult to find the right contractor for your job and to continue receiving quality work if your preferred contractor isn’t available.
Benefits of hiring a W-2 employee
Most companies rely on employees to do the bulk of their day-to-day work. Hiring W-2 employees versus 1099 contractors can be a great way to manage your staffing concerns and ensure that work is done consistently and regularly. You won’t have to scramble to find someone to fill a role because your employees are already there.
Having employees gives you more control over the work done. You can monitor their work, require certain hours, and ask them to prioritize their tasks.
Another benefit of hiring W-2 employees includes budgeting. Since most employees work regular hours, you’ll have a good idea of how much you will spend each month.
Cons of hiring a W-2 employee
While there are a lot of benefits to having employees, there are some cons as well. Having employees means needing to comply with employment laws ranging from hourly pay to paid family leave. Most employees also expect benefits like vacation pay, contributions to retirement accounts, and health insurance.
Hiring employees may also mean adding human resources staff or paying for human resources software to ensure your paperwork and employment practices comply with state and federal laws.
Instead of simply writing a check as you would for a contractor, having employees means withholding taxes and filing employment tax returns quarterly and annually. You’ll also need to pay the employer portion of Medicare and Social Security taxes as an employer.
Different work arrangements for 1099 contractors versus W-2 employees
Independent contractors work differently from employees. Here are a few ways hiring could look different between 1099 contractors and W-2 employees.
Starting work
Most independent contractors will require you to sign a contract before they begin working. The contract generally gives the scope of the agreement, outlines any deadlines, and gives parameters about how and when payment will occur. Many contractors may require payment upfront before they even begin working on the job.
However, for W-2 employees, starting work often involves a more typical process where they interview, are hired, go through some level of onboarding, and then work a regular schedule doing whatever duties you have assigned to them.
Payment
As mentioned, 1099 contractors are often paid irregularly. This could include partial payment up front, with the rest due once the job is complete. Other arrangements include paying a monthly retainer for services outlined in a contract or billing on an as-needed basis as work is completed.
W-2 employees are paid via a paycheck, usually weekly, biweekly, or semimonthly. The payment amount will either be their regular salary or hourly wages and is paid after the work is completed. Payment is usually based on the amount of time they work rather than on certain tasks being completed.
Monitoring work
Every workplace is different, but some employers prefer to know when their employees are working and what they’re working on. This ensures projects run on time. Moreover, it ensures that everyone is on the same page with who is doing what. This helps everyone progress in their tasks.
However, this type of monitoring isn’t possible with contractors. In fact, you shouldn’t require too much hands-on oversight of your contractors. The IRS may ask you to change their classification from contractor to employee.
Completing work
For most employees, their work is never really “finished.” They may finish their tasks for a project or for the day. Still, they’ll come to work the next day. They have a continuous stream of tasks.
However, it’s different with 1099 contractors. If their contract is based on a specific project, their work may be completed when the project is complete. That could be the end of your relationship with your contractor. However, you can engage them again to perform a new service or complete a new task.
Taxes and tax forms
As we’ve already discussed, employers who hire employees are responsible for withholding state and federal income taxes and unemployment taxes. This includes paying and withholding Medicare and Social Security taxes. They are also responsible for filing employer tax returns such as the following:
- Federal Forms 941 or 943,
- Creating a Form W-2 for each employee at the end of the year. Employers should also make sure their employees’ complete Form W-4 for tax purposes.
Contractors should complete a Form W-9 for you so that you can properly report the income they receive from you. Even though you don’t have to withhold or pay taxes for 1099 contractors, you are legally required to issue a Form 1099-NEC (Nonemployee compensation) if you paid your contractor $600 or more during the calendar year. Similar to Form W-2, this is due by January 31 for the preceding calendar year. A copy must be filed with both the IRS and sent to the contractor.
Final thoughts on 1099 contractors versus W-2 employees
Contractors may better fill some roles in your company. However, in many cases, hiring an employee may make the most sense. Whichever method you choose, make sure you’ve classified your employee or contractor properly. There are stiff penalties for classifying workers incorrectly, so it’s important to classify every worker the correct way.
Having reliable, experienced people on your team is an important part of running a business successfully. Just make sure you’re hiring the right type of people for the job and that you’re following the IRS’s rules when classifying your workers.