1099 vs W2 Employee – Which Is Better for Your LLC & Business
Human resource professionals have a very important job to keep the business in compliance with rules and regulations while also administering payroll, managing employee relations, handling onboarding, and a miriad of other HR tasks.
Many small business owners wear multiple hats, including that of the HR manager, and one major part of this role is deciding whether to hire 1099 workers or W2 employees.
These two types of workers have major differences and classifying them correctly with the IRS is very important.
Failing to properly classify workers and employees could lead to fines and penalties from the IRS as well as the possibility for lawsuits against your business.
Aside from the legal implications, there are different pros and cons for both hiring employees and independent contractors.
There is no right or wrong answer because the right choice for your business will be unique from the right choice for another business.
In this article, we will define what 1099 workers are, what W2 employees are, discuss the difference, and give you some information to help you decide what’s best for your business.
By the end of this article we hope you will have enough knowledge to apply to your business when it comes to hiring individuals to help your business grow.
Let’s get started!
1099 workers are more commonly called independent contractors.
Independent contractors are self-employed individuals who perform contracted work or provide contracted services to another non-employee entity.
Some independent contracts are hired on a project basis while others can be hired on a term basis or for a specific period of time.
Because independent contracts are self-employed, they themselves are also business owners.
Independent contracts serve multiple clients and define for themselves how, where, and when they work as well as their rates and methods for performing the work or services.
When a business wants to hire an independent contractor to perform a job or service, they will usually engage in a contract with the independent contractors that outlines the scope of the work to be done as well as the rate and duration of the project.
Once the project is complete, the business and independent contractor can choose to extend or terminate the contract with no further obligations towards one another.
For this reason, many business owners choose to hire independent contractors for jobs that have a more defined period of time as opposed to hiring W2 employees for an undefined period of time.
Furthermore, business owners have relatively low oversite over independent contractors, meaning that there is less legal and financial responsibility involved.
1099 workers are responsible for paying both employer and employee self-employment taxes which means the business is not responsible for filing or paying payroll tax for work performed by the independent contractors they hire.
1099 workers are also not eligible for employee benefits such as healthcare, 401(k), PTO, or overtime.
While independent contracts are their own business owners, employees are the opposite.
They are not their own business owners because they work for a company, usually on salary or on an hourly basis.
W2 employees are also called salaried employees and by law, they are guaranteed at least a minimum wage, which is set by both state and federal laws.
Companies that hire W2 employees are responsible for withholding Social Security and Medicare taxes for their W2 employees and they must pay employer payroll taxes.
Independent contractors are usually responsible for providing their own tools and supplies while W2 employees are provided all the necessary tools and supplies to perform their job by their employer.
Furthermore, qualified W2 employees usually participate in an employee benefit program which can include PTO, 401(k), overtime, health insurance, expense reimbursements, and more.
Companies can let go of W2 employees for poor performance or other valid reasons while independent contractors work and receive their pay according to the terms of the contracted that both parties signed and agreed to.
Deciding which employees are 1099 or W2 Employees
As mentioned above, correctly classifying your employees with the IRS is extremely important.
To be frank, hiring independent contractors is usually much easier than hiring employees and administering payroll and ensuring the proper classification.
That being said, it can quickly become a nightmare if the IRS or Department of Labor audit you and discover that you have misclassified your workers.
This could lead to penalties, fines and back taxes for wages going back as far as three years or more.
To help you decide whether workers should be classified as 1099 workers or W2 employees, the IRS gives us a few helpful guidelines:
- Behavioral – Who controls what, where, how, and when the worker carries out their job?
- Financial – Who controls the business aspects of the worker’s job (expense reimbursements, who provides tools or supplies, etc)? What is the method in which the worker is being paid – flat fee, hourly, regular salary?
- Type of relationship – Does the worker receive employee benefits? What are the length and terms of this relationship, as outlined in a contract, employment agreement, other documentation?
When the IRS reviews the classification of a 1099 or W2 employee, they really are looking at the level of control the business has over the worker.
Is the business controlling most of what the worker is doing? If yes, then the worker should probably be classified as a W2 Employee and treated as such.
However, if the worker has a relatively good degree of independence then they are most likely a 1099 worker.
If you still aren’t 100% sure how to classify a worker, we always suggest consulting an attorney or completing Form SS-8 with the IRS.
The Form SS-8 is the Determination of Worker Status form that you can complete and submit to the IRS for review.
The IRS will review the form and decided how you should classify your employee, just keep in mind that this process can take up to six months.
1099 vs W-2: Which is the right choice for your business?
Now that you have a better understanding of what each type of classification is, it is time to see which option might be the best fit for your business.
Many small businesses choose to work with independent contractors because of the cost savings and lower risk involved.
On the other hand, other businesses choose to hire W2 Employees for stability, longevity, and loyalty.
Here are some pros and cons of each type:
PROS of 1099 Workers
- Tax savings – the company doesn’t withhold income taxes, doesn’t pay Social Security and Medicare taxes, and doesn’t pay unemployment taxes on the earning of their independent contractors.
- No classification of workers involved
- Less legal and financial responsibility involved
- Reduced business costs – do not have to provide benefits such as healthcare, 401(k), PTO, or overtime
- Specialized expertise
- Only pay for the staff you need
- Independent contractors pay their own taxes
CONS of 1099 Workers
- Independent contractors can choose whether they want to come to work or not without fear of losing their employment
- Might be harder to perform background or reference checks
- Can actually be more expensive by the hour or by the project depending on scope of work end level of expertise
PROS of W2 Employees
- Greater control over working hours and conditions
- More continuity in employment
- Ability to attract and retain high performance employees
- More control over their workforce
CONS of W2 Employees
- More expenses for employers, including payroll taxes, insurance, and more.
- Increased legal complexities such as classification of employees, disability leave, etc.
- More time spent on training and onboaring new employees
As you can see, there are pros and cons to each type of classification and at the end of the day, you can’t really say a 1099 worker is better or worse than a W2 employee because the choice between the two really comes down to your business’s need.
These needs can include: the type of work you need done, your schedule, the amount of control you want to have, and your level of involvement.
To help you further understand how these apply to your business, let’s share a few example scenarios next.
When to hire Independent Contractors:
- Short term projects that have a specified period of time to completion.
- Functions that only require a few hours per week or month such as Accounting or Bookkeeping services – many small business owners don’t need a full or part-time person for accounting and bookkeeping. Hiring an independent contractor for a few hours a week is a cost effective way to handle this role. This can also apply to HR tasks, and other roles within the company.
When to hire W2 Employees:
- Seasonal work such as holiday hours at a retail store – if you have a retail location that needs seasonal workers, hiring them as a W2 Employee is the correct classification because you need the workers at your location for a specified schedule.
- You need to train someone to complete a very specific set of processes that you have a lot of control over.
- You need someone to perform a job during specific hours on specific days/times.
Again, there are so many different scenarios, these are just a few to help you gain a better understanding.
As mentioned before, if you are unsure, it is wise to contact an expert such as an employment lawyer or other professional.
How to Pay 1099 vs W2 Employees
1099 Workers and W2 Employees are paid quite differently.
1099 workers are paid a flat-fee for services rendered.
Usually this fee was agreed upon beforehand between the Independent Contractor and the business via some sort of contract or scope of work.
Both parties agree on how the payment will be made and this is usually done either in increments as work is completed, or at the end of the project.
Independent contractors are responsible for paying their own taxes and expenses which means employers are not required to track or pay federal, state or local taxes including Social Security, Medicare, workers compensation, or unemployment taxes.
Employers are only required to supply the independent contractor with a Form-1099 at the beginning of the year for any payments made to them in the previous year.
W2 Employees on the other hand are paid on an hourly or salaried basis, usually on some sort of consistent schedule (once per month, twice per month, weekly).
Employers are required to issue an IRS Form W-2 to employees each year that shows their gross wages and income tax withholding.
FundsNet requires Contributors, Writers and Authors to use Primary Sources to source and cite their work. These Sources include White Papers, Government Information & Data, Original Reporting and Interviews from Industry Experts. Reputable Publishers are also sourced and cited where appropriate. Learn more about the standards we follow in producing Accurate, Unbiased and Researched Content in our editorial policy.