It isn’t always easy doing business in today’s world.
This statement couldn’t be more true when it comes to classifying your employees. Therefore, knowing the difference between 1099 contract workers and W-2-issued employees is beneficial, even if you have an accountant or a third-party company in charge of payroll processing. This is because hiring an employee or an independent contractor influences how you and the individual are taxed.
To elaborate, you don’t usually have to withhold or pay taxes on compensation to an independent contractor, but the opposite is true for an employee. This means that you are liable for withholding and paying income and unemployment tax on wages paid to an employee, as well as Social Security and Medicare taxes.
So, before deciding whether to employ independent contractors or employees, let’s go over the primary differences between them.
The most obvious difference between an employee and an independent contractor is that the former is hired by a company under an employment agreement, while the latter is self-employed. This affects how and when these individuals work; as an employer, you dictate your employees’ hours, but independent contractors are in charge of their own work schedules. Independent contractors may also be referred to as freelancers or self-employed workers.
Another difference is that employees often wear many hats and can lend a helping hand where needed, whereas independent contractors typically offer specialized expertise or services that you might use for completing a specific project. They may also work for multiple businesses at a time.
Finally, employers need to fulfill certain responsibilities when it comes to employee management. This includes all business aspects of the worker’s job, like organizing schedules, paying wages, and withholding taxes from paychecks. You might also provide benefits and training. Self-employed workers, on the other hand, are liable for their own taxes and do not usually receive employee-type benefits.
W-2s and 1099s are tax forms. A W-2 tax form is used for employees (whose employer is liable for withholding payroll taxes from their wages). A 1099-MISC, on the other hand, is used for disclosing payments made to independent contractors (who pay self-employment tax).
Now that we’ve covered the basics, let’s look at the topic in more detail.
You need to fill in and file a W-2 tax form whenever you hire a new employee. This is used to disclose the annual wages paid to your workers and the payroll taxes withheld from those wages. In other words, W-2 employees are paid through the company’s payroll and have their employment taxes withheld throughout the year.
1099 tax forms apply to contractors rather than full-time employees. If you are a company that is hiring 1099 employees, determining the type of work these individuals will perform for your business will help to establish what you as the business owner could be liable for in terms of remuneration and benefits.
What follows is a breakdown of the three primary differences between W-2 employees and 1099 independent contractors:
At will employment refers to your ability as an employer to dismiss an individual for any reason you see fit, provided it is not illegal.
Business owners have different tax obligations when it comes to having a full-time employee versus a contracted employee.
Many business owners prefer to hire an independent contractor due to their obvious benefits. These include saving on employment taxes, insurance, and benefits. Put simply, independent contractors are often more cost-efficient than full-time employees.
There is also no legal requirement for workers’ comp or extensive tax obligations with an independent contractor, which means less hassle for business owners. Additionally, you are less likely to get sued by an independent contractor since they are not considered employees, and many employment laws don’t apply to them. However, with the advantages come drawbacks, which we will discuss in more detail below.
Independent contractors often charge a higher hourly rate for their services since they are liable for paying their own taxes, insurance, and other benefits like health care. They also enjoy a higher degree of autonomy, work their own hours, are often involved in multiple projects at once, and typically aren’t available at the drop of a hat. They might not even work in-office.
With W-2 employees, on the other hand, you get the benefit of a ‘team’ environment, where workers can be counted on to pitch in, work after hours, and get the job done. In other words, if you want something done in a certain way at a certain time, hiring an employee is in your best interests.
The difference between an independent contractor and an employee can be summarized as the degree of autonomy the worker has or the amount of control you as the employer have over them. This is rather vague as far as definitions go, so the Internal Revenue Service has compiled a list of three guidelines that you can use for classifying potential employees. These guidelines require you to consider your entire relationship with your employee and the degree to which you direct that person in their work. They are as follows:
No, contractors are not employees. On the one hand, this means you have less control over the work performed by contractors, but on the other, it means you are exempt from filing payroll taxes on their paychecks, which usually include income taxes, unemployment insurance, and Social Security and Medicare taxes.
You can easily transition your 1099 contractor to a W2 employee by hiring them to fill a vacant position in your company. Of course, this means you will need to start withholding and paying payroll taxes on their wages.
However, converting an employee into a contractor is a much more complicated process. This is because workers are considered to be employees unless proven otherwise, so transitioning from a W-2 to a 1099 may result in questions from the IRS. It is, therefore, in your best interests to consult with a lawyer and an accountant before making any changes.
Not necessarily. Often, independent contractors will charge more per hour due to their specialized expertise (which is what you’re hiring them for). That being said, you are not liable to pay unemployment tax, Social Security, or Medicare tax when you hire a contractor. As a result, many business owners find that independent contractors cost less than full-time employees.
Note, however, that classifying your workers incorrectly can result in stiff penalties. The best way to avoid this is to ensure you classify your employees and contractors correctly by following the guidelines set out by the IRS above.