It’s understandable for small business owners to feel overwhelmed by employee classifications. When the time comes to expand and hire employees, it’s crucial to know the difference between a 1099 contractor and a W2 employee. Otherwise, business owners risk making mistakes on taxes, or even dealing with legal issues.
But more than that, a 1099 contractor vs. a W2 employee function differently as part of a business. Knowing whether to hire 1099 contractors or W2 employees can make the difference in a business getting what it needs from its employees.
What is a 1099 Employee?
A 1099 worker is an independent contractor, which means they’re technically not an employee. An independent contractor is a self-employed professional a business pays to perform a specific function. For example, a business might pay a freelance web designer to build a website, or an accountant to take care of finances.
According to the IRS, if a business pays $600 or more to a non-employee for business services, that needs to be reported both to the government and the person who was hired. 1099 contractors are perfect for short-term projects. When first retained for work, every 1099 contractor needs to fill out a W9 form so the employer can send the IRS the appropriate records, and the IRS can make sure the contractor pays their own income taxes.
What is a W2 Employee?
A W2 employee, on the other hand, is a traditional employee. They work for a business part-time or full-time, and they might be eligible for benefits like health insurance and pension plans. A W2 employee is usually more of a long-term position than a 1099 contractor. Unlike freelancers, they are not considered to be their own business. Instead, they are a part of the business that employs them.
Unlike a 1099 contractor, who is responsible for withholding their own income tax, W2 employees have tax deductions automatically taken out of their paycheck. The IRS guidelines state that employers legally need to ensure all employees have their W2 forms by no later than January 31. This ensures that employees are able to file taxes in a timely manner.
How to Know Whom to Hire
There are potential pros and cons to hiring W2 employees or 1099 contractors, so any potential employer needs to be clear about what their needs are.
A W2 employee might be more loyal to the business, simply because they aren’t running a business of their own. They’re dedicating their time and energy to the business that employs them as opposed to juggling multiple employers as clients. Employers often have more control over the work product of a W2 employee, and due to the nature of scheduled part-time or full-time employment, they have much more control over how that employee spends their time.
However, W2 employees can cost a business more money than a 1099 contractor. Benefits, salaries, and simply paying for that much of someone’s time is much more costly than paying someone for a single project. Furthermore, W2 employees need more time and attention than 1099 contractors. Any good business needs to make sure its employees are well-managed, otherwise workers will quit instead of risking relying on an employer that doesn’t return their investment.
When employing independent contractors under a 1099, employers are not required to withhold income taxes or pay for benefits like insurance or retirement planning. Because an independent contractor depends on maintaining a good reputation from clients for their business, any potential employers might find it easier to look at references and examples of work to get a good idea of what they can expect from that worker.
But 1099 workers have more rights over the work they do, and more control over their time and efforts. They might not be motivated to build the kind of relationship with an employer that the business needs.
The Risk of Getting it Wrong
Some questions a business might ask themselves before deciding which to hire might include:
● Do I need ongoing help or a discrete project to be done?
● How long will I need the employee to work for me?
● Does my company have the resources to pay for a full or part-time salaried worker?
● How do other businesses in my industry handle employment?
Beyond getting the type of work you need from a potential worker, misclassifying workers can have serious legal implications.
At the extreme end of the spectrum, consider the ongoing legal issues with Uber. Of course, a huge business like Uber is going to be more likely to get into legal hot water than a small business struggling to get employment right. But the law is the law, and mistreating employees by classifying them incorrectly is no way to succeed in business.
When in Doubt, Ask an Expert
Any potential employer who is new to hiring employees should consult an expert in employment law, or any industry mentors who have experience with both contractors and traditional employees.
Whether it’s a mistake on annual taxes, a lawsuit, or just a failure to get the best out of employees and freelancers, hiring classifications are too important to get wrong.