Clever RX
6 min read

Do your Employees Classify as 1099 or W-2?

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There are a myriad of decisions for business owners. Making sure you have classified your staff correctly in the eyes of the IRS is one of the most fundamental decisions you will make. What are the differences between a W-2 and a 1099? If an employer offers the wrong form to an employee, it could result in potential fines. To avoid this issue, let’s look at the differences between 1099 and W-2 employees. W-2s and 1099s are tax forms used to deduct payroll taxes on different types of employees.  1099 employees are self-employed independent contractors and get a 1099 form to report income on their tax return.  1099 employees receive pay in accord with the terms of their contract.  A W-2 employee receives a regular wage and employee benefits.  The employer withholds income taxes from the employee’s paycheck and has a significant degree of control over the employee’s work.

For a small business staffing is an important decision to consider.  Managing human resources is challenging.  It is the employer’s responsibility to handle onboarding, training, payroll and employee relationships as well as other HR tasks.  Given these considerations many small business owners weigh the pros and cons of whether to hire a 1099 or W-2 employee for certain positions.  Classifying your workers properly with the IRS is important.  If you have any doubts you may want to hire an employment attorney to help you classify your workers.  Doing this could prevent penalties from the IRS and lawsuits against your business.  Keeping this in mind let's explore some the fundamental differences 1099 and W-2 employees.

 What is the difference between a 1099 employee and a W-2 employee?

1099 workers (independent contractors) provide specific services as defined by a written contract. They work within their specialty. Some independent contractors work on one project others serve multiple clients. Businesses hire independent contractors for a defined period of time as per conditions outlined in the contract. The engagement may be renewed as many times as both 1099 employees and the business owner find mutually beneficial. Independent contractors assume the risk for their own profit or loss when they carry out their jobs. 1099 employees define for themselves how and where they work, and what tools and methods they use to complete the work you hired them for. They also choose to hire their own workers to help them deliver the product or service that you hired them to provide. The employer’s level of oversight is relatively low, therefore so is your financial and legal responsibility. 1099 employees pay their own employment tax, the employer is not responsible for employment tax as they would be for a W-2 employee. A 1099 employee is in a sense their own business, therefore they are responsible for their health insurance, paid time off and overtime.

What is a W-2 employee?

W-2 employees report directly to their employer. The employer pays them a salary of at least minimum wage. The employer withholds Social Security and Medicare taxes and pays payroll taxes. Employers provide all the necessary tools and supplies for W-2 employees. Independent contractors must provide their own. In addition, employees are reimbursed for business expenses they incur over the course of their employment. In most instances this is not the case for an independent contractor unless it is specified in their contract. Benefits like health insurance, retirement contributions, and flexible spending accounts are available to all qualifying employees in a business. In contrast benefits are not available to independent contractors doing work for a business.

How does the IRS breakdown the differences between a W-2 and 1099 employee?

The IRS considers three major categories in determining whether workers are employees or independent contractors:

  1. Behavioral – Can your business control what, where, how, and when the worker carries out their job?
  2. Financial – Who controls the economic aspects of the worker’s job? What’s the method of payment (e.g., a regular salary or a flat fee)?
  3. Type of relationship – Do you provide this worker with employee benefits? What are the length and terms of this relationship, as outlined in a contract, employment agreement, other documentation? 

1099 Independent Contractors

  • Bring specialized expertise
  • Offer greater flexibility
  • Less legal risk to your business
  • May lower business costs
  • Self-employed
  • Hired for specific projects
  • You have no control over when and how they complete their jobs
  • You are not responsible for their Social Security or Medicare taxes
  • You will not provide them with the same benefits as a W-2 worker
  • May be the a less expensive option

W-2 Employees

  • Committed to your company
  • Provide continuity with business philosophy
  • Allows the business owner to delegate a variety of tasks to employees – freeing up time to take care of higher level responsibilities
  • Train employees just once
  • Ability to cross train over departments enabling flexibility when needed
  • Regular salary
  • Provide certain benefits
  • More management
  • You would have a steady team of employees
  • Trained and managed according to your standard

One of the most important decisions you will make as a small business owner is how to staff your organization. Carefully weigh a few considerations before making your decision. This includes the type of work you need to be completed, how quickly you need the job done, whether the job is a one-time or regular commitment, and the costs associated with hiring 1099 vs. W-2 worker. Consulting an employment attorney and tax professional will give you a thorough understanding of how best to staff your business. In the end it comes down to your business’s budget, the type of work, and the amount of control you would like over the process and the product.  There are benefits to both sides it's up to you to find the answer that works best for your specific employment situation.  

Contact AAP for more information.

 Sources:

Fundera; “1099 vs. W-2 Employee: Which is Better for Your Business?” 10/27/2020  (https://www.fundera.com/blog/independent-contractor-vs-employee)

IRS.gov; Independent Contractor (Self-Employed) or Employee?