1099 vs. W-2: What’s The Difference?

You’ve most likely heard the terms 1099 and W-2, but do you understand the difference? There are benefits and drawbacks to each. You might choose to go with one method exclusively in your business, or you might utilize both.

1099 contractors are self-employed individuals that you use in your business to complete specific tasks. W-2 employees are traditional employees who are under your full control.

The bottom line is that you must understand the difference so you can choose correctly for your company. If you don’t, it could you cost you a lot of time and money in the future.

What Are 1099s And W-2s

1099s and W-2s are both technically tax forms but they often refer to the type of employee that receives them. 1099s are sent to independent contractors to whom you paid more than $600 in the calendar year.

W-2s are sent to employees to record the amount you paid them and the taxes you withheld during the year.

Both forms are filed annually. Here’s a little bit more information about each of them.

1099

A 1099 is a record of the money you paid for services performed for your business in a calendar year apart from a formal employment contract. Typically you use a 1099 for any freelancers or independent contractors whom you pay to do work for your business.

This is a standard 1099-NEC.

1099-NEC

The 1099-NEC asks for the following information.

  • Your name, address, telephone number, and EIN as the payer
  • The name, address, and EIN of the person you paid
  • How much money you paid this person
  • How much (if any) federal income tax you withheld from their payments

You must give someone a 1099 if you have paid them $600 or more in a calendar year. This is an official tax document that gets sent to both the person you paid for their tax records and reporting, as well as the government for their records.

There are 18 different kinds of 1099s. The 1099-NEC is what’s used for freelancers and independent contractors. When you file 1099s for your independent contractors, you’ll also need to file a 1096. This is just a summary of all the 1099s you sent that year.

1096

By law, you must have all of your 1099s postmarked and in the mail by January 31 at the latest.

W-2

A W-2  is a wage and tax statement that is sent to the IRS and to your employee. It lets both of them know that this person is your employee, how much money you paid them, and how much taxes were withheld from their paychecks.

This is a standard W-2.

W2

The W-2 asks for the following information.

  • Employee’s social security number (SSN), name, and address
  • Employer’s EIN, name, and address
  • Wages earned by the employee in the last calendar year (including tips, if applicable)
  • Amount of taxes withheld
  • Dependent care benefits (if applicable)
  • Other types of compensation (if applicable)

All of your employees receive a W-2 every year they receive income. There is no minimum amount you need to be paid in order to get a W-2, and employees hired with a W-2 can be either part-time or full-time.

Like the 1099, you must have your W-2s postmarked and in the mail to your employees by January 31.

Related: Year-End Checklist For Small Businesses

How To Determine Employee Status

It is absolutely critical to properly categorize employees.  The IRS has a list of three criteria to help you determine whether your employee should be a 1099 vs. a W-2. These are directly from their website:

  1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

How you answer those questions will help you determine how you hire. It’s definitely a gray area, so pay careful attention to this and use your best judgment. If you have questions, consult a tax professional or an attorney.

Related: 15 Valuable Small Business Tax Deductions

Benefits Of Hiring As A 1099 Contractor

There are significant benefits if you can get help from independent contractors. Most notably is that you don’t have to pay payroll taxes, process payroll, provide any benefits, or provide worker’s compensation insurance or unemployment insurance.

No Need to Withhold or Pay Payroll Taxes

FICA taxes (Social Security and Medicare) are paid half by employees and half by the company. If your worker is a 1099 independent contractor you are not responsible for withholding their portion of FICA taxes or paying the company portion. They are responsible for paying the entire thing themselves.

Besides being a huge cost savings, you are relieved of the burden of processing payroll. No need to calculate, withhold, pay, or submit payroll taxes.

You Don’t Have To Offer Benefits

1099 employees are on their own when it comes to their benefits. They’ll need to secure everything by themselves rather than depending on your company for them.

This includes health insurance, sick and vacation time, retirement plans etc.

But it also includes benefits such as worker’s compensation and unemployment insurance. Again, these costs are saved by the company as these benefits must be provided to W-2 employees by law.

Your Working Relationship Can Be Short-Term

Sometimes you only need assistance with your business for a designated period of time. For instance, if you don’t want to hire someone full-time to do tech for your business but you really need help designing your website, you might hire a designer only while the website gets up and running. When the job is done, so is the working relationship.

When it’s time for them to leave, you don’t need to lay them off or fire them. The contract simply ends.

Drawbacks Of Hiring A 1099 Contractor

While there can be significant savings and reduced responsibility when hiring a 1099 contractor, there are drawbacks as well.

No Permanent Relationship Means No Long-Term Loyalty

By the nature of their employment, 1099 employees are not committed long-term to your business – they have their own business. So while they may have a significant amount of themselves and their reputation invested in a certain part of your business, they are ultimately focused on their own business.

You Have Little Control Over How A 1099 Contractor Works

Part of what separates a contractor from an employee is the amount of control you have over their work. You can’t tell a 1099 contractor what hours to work, what software to use, or generally how to do their job at all.

If you have a full-time W-2 employee, you know how much sick and vacation time that employee has. You know when they’re going to be working on their projects for you and how those projects are progressing because they constantly report to you. They have a vested interest in doing well so that you’ll keep them on.

Not so with a 1099 contractor. Often they’re working from their own office, from home, a coffee shop, or somewhere else apart from you. It’s up to their level of customer service as to how often they check in with you.

Beware Of Your Insurance Liabilities

If you do have 1099 contractors coming on-site, understand what happens if they are injured while on your premises, or injure others. Or what happens if their work causes injury to one of your employees or customers – can you be sued?

Think about if you hire painters to repaint your offices and a ladder falls and injures your employee. Or if the paint fumes make someone ill. Who is responsible?

You may want to talk to either a tax professional or a lawyer to see how situations like this would play out for you in your business and ensure you are properly protected.

Benefits Of Hiring A W-2 Employee

Like with 1099 hires, there are good reasons to hire people with the W-2 and reasons why you might stick with the 1099. This list may look a little like reading an opposite version of the 1099 list.

You Have Full Control Over Your W-2 Employees

You can tell a W-2 employees what hours and days they need to work, how many vacation days they get, where to sit, how to dress, what to say when they answer the phone, etc.

You have full control W-2 employees. From what work they do to how they do it.

Loyalty Is Expected

When you welcome someone as an official part of your business, whether full- or part-time, you set expectations for them. One of those expectations is loyalty. They should be just as invested in the success of your company as you are. After all, if they’re not, they may lose their jobs.

The Commitment From The Employee Is Usually Long-Term

While hiring someone with a W-2 is no guarantee that they’ll be with your business for years, there is a commitment on both sides when you sign that document. The new employee is being recognized for having gifts and talents valuable to growing the business. As the employer, you are investing time, energy, and money into your new hire. You don’t invest in 1099 contractors the same way.

Drawbacks Of Hiring W-2 Employees

Having more control and a longer relationship with employees is a great benefit to employers. However, there are drawbacks.

W-2 Employees Are More Expensive

As we’ve mentioned, you’ll have to pay payroll taxes on this employee, which is half of their FICA taxes. You’ll also have to provide unemployment and worker’s compensation insurance. If they work on your premises you’ll likely also need some sort of liability insurance.

You’ll also have to potentially pay for benefits, money into their retirement account, health insurance, training, continuing education, mileage reimbursements, office space and a computer for them to do their work, etc.

Obviously, not all of these may apply to your business model, but it’s likely at least a couple do.

W-2 Employees Are More Work For You

You may not even require a formal contract to hire a 1099 contractor, and if you do, they will probably provide it themselves. Hiring a W-2 employee is more complicated.

You’ll need to follow the hiring laws in your area and set up and maintain a place for them to work. You might need to train them and watch them to ensure they are following your standards. It’s a commitment you make to this employee to take the time to get them set up correctly in your system and that they know the rules of your business.

How To Choose Which Is Best For Your Business

In general, it’s going to be easier to hire a contractor vs an employee. The question really is how much control do you want to have over your new worker? If you just need a specific output and you don’t care how or exactly when it gets accomplished then a 1099 contractor might be your best bet.

However, if you want or need someone to report in every day at a set time and do things to your exact specifications then an employee might be more what you are looking for.

For example, if you need someone to sit at the front desk to answer the phones and greet clients as they arrive then you’ll likely need an employee. If you need someone to put proposals together and email them back to you by the end of day Friday, then that might be more of a role for a contractor.

Keep in mind that which you choose can have major ramifications. If you misclassify an employee as an independent contractor, you could face penalties from the IRS. Here’s more information on that.  But trust me, it’s something you’ll want to avoid.

And while you can switch an independent contractor to a W-2 employee and vice versa, it can get really complicated and you may need to pay a tax professional to help you sort it out.

Related: Why Accounting Is Important To Your Small Business

Final Thoughts

In general, if you can choose a 1099 contractor that will be the easier and cheaper option. And sometimes the role of 1099 vs W-2 is fairly straightforward — but sometimes it’s not. And misclassifying an employee as a 1099 contractor can mean large fines from the IRS so if you are unsure it’s best to speak to a lawyer or accountant.

But either way, take the time to hire your employees correctly right from the start and save yourself time, money, and a lot of hassle.

1099 vs w-2

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