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W-2 vs. 1099: Choosing between employees and contractors

Editorial Team

5 min read
Two construction workers

At a certain point, nearly every successful small business owner thinks about expanding their operations. To do so, they often need to onboard additional staff – whether this involves hiring family members, recent college grads, or remote freelancers.

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Either way, the majority of new hires will likely fit into one of two categories:

  • W-2 employees – these workers report their earnings on a W-2 IRS form
  • 1099 contractors – these self-employed individuals report their earnings on IRS form 1099.

What are the primary differences between W-2 and 1099 workers? Which represents the better staffing option for your business? This issue can be complicated, which is why there are specific rules and regulations in place regarding classification of workers. Misclassification can result in serious consequences for your business.

Read on to learn more, and check out this article to help determine classification status.

What is the difference between W-2 and 1099?

W-2 employees work for an organization, receiving all salaries, wages, and employee benefits directly from their employer. The organization is responsible for withholding applicable taxes from each paycheck, removing the need for employees to set aside these funds.

By contrast, 1099 workers are self-employed independent contractors who receive a set fee or hourly wage based on whatever agreement they have with their client. Each 1099 contractor is responsible for covering all benefits, taxes, and Social Security withholding entirely out of their pockets.

Which type of worker to bring onto your team depends on the nature of your business, the nature of the work to be performed, and other factors. Many companies ultimately using a combination of employees and contractors. The rest of this article explores the benefits of 1099 vs. W-2 workers.

The pros and cons of hiring W-2 employees

W-2 employees are more familiar to most of us. Whether hourly or salaried, most employees draw a regular paycheck in exchange for their work. Although not every W-2 employee receives health insurance, many receive various benefits that are fully- or partially-covered by their employer – including workers compensation, sick leave, overtime pay, office-related reimbursements, vacation time, and 401K retirement matching.

In addition, employees are not expected to provide tools or resources to perform their jobs. The employer supplies those. With few exceptions, companies are legally prevented from paying W-2 employees below the minimum wage.

The pros and cons of hiring 1099 contractors

When bringing on a contractor, you pay a set salary or retainer for work performed. As a client, you’re not responsible for any benefits, reimbursements, or other expenses that the contractor might incur while delivering this work. You don’t even have to pay payroll taxes, since contractors aren’t employees – they are independent business owners.

Contractors often cost more per hour than employees with equal experience and training. However, because you only pay for hours worked, using a contractor is sometimes the most economical option. However, the same IRS disclosure rules apply. You still need to report your contractor’s earnings each year on a 1099 form vs. a W-2 form for employees.

Now that you understand the benefits of 1099 vs. W-2 staff, which makes the most sense for your business?

Is it better to be a W-2 or 1099 employer?

There is no universal right answer for all businesses, but as a general rule:

  • Contractors are best suited for short-term projects – especially when you lack the expertise or manpower in-house. For example, you might bring on temporary freelancers to help with a site redesign or product launch. Using contractors also appeals to those on a tight budget, since you can avoid many of the costs associated with hiring, training, and keeping full-time employees.
  • Employees are best suited for companies that have the resources to recruit and cultivate talent over time. This approach is particularly useful for businesses with internal processes that require training. If you’re going to invest in people, you want them to stick around for as long as possible. Entice potential W-2 employees with an attractive salary, supportive culture, and plenty of employee benefits.

If you’re still concerned about the difference between W-2 and 1099, think of it this way: contractors can help solve short-term problems, whereas employees are more ideal for developing long-term solutions.

Using W-2 and 1099 workers

There was a time when being an employee meant being physically present at your place of work. Only contractors could come and go as they pleased. Today, the internet has reshaped the business landscape, allowing many people to perform essential duties remotely.

Many employees were forced to work from home as a result of COVID-19. As telecommuting becomes the new normal, some of the traditional differences between W-2 and 1099 workers are starting to blur together. After all, it’s becoming increasingly possible to hire anyone from anywhere in the world.

However, it’s still important to correctly classify workers as W-2 vs. 1099 for tax purposes. Labeling a contractor as an employee (or vice versa) can get you in serious legal and financial trouble. If you’re not sure which classification to use, the IRS recommends that you use the following determinations:

  • How much behavioral control you have. You can tell employees when and where to work, but contractors normally follow their own hours and procedures.
  • How much financial control you have. For example, employees rarely have to pay for tools and supplies out of pocket. Contractors, on the other hand, are expected to cover all their expenses.
  • The type of relationship you have. Whereas employees and contractors might sign a contract, only the former can expect perks such as benefits. Moreover, most 1099 contracts stipulate an end date.

If you have questions about tax filings, payroll, or other small business concerns, our Business Consultants can show you how Clover POS solutions integrate with many software programs to help you run your business. Connect with a consultant today.

This information is provided for informational purposes only and should not be construed as legal, financial, or tax advice. Readers should contact their attorneys, financial advisors, or tax professionals to obtain advice with respect to any particular matter.

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