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As a business owner, choosing what type of staff to hire has significant implications for your business.
Before you begin the hiring process, make sure you understand the distinctions between W-2 employees and independent contractors. There are pros and cons to both options (as well as important legal distinctions), so let’s go over the differences and how to decide which is best for your business goals.
At a glance:
- W-2 employees are regular staff subject to tax withholding, while 1099 workers are self-employed contractors.
- Classification depends on factors like behavioral and financial control and the nature of the relationship.
- Misclassifying workers can lead to legal and financial consequences.
What are W-2 employees?
W-2 employees are traditional employees hired by your company to do work on a regular basis. Depending on your needs, you can hire W-2 employees to be either full-time or part-time.
These employees are subject to tax withholding — that’s where IRS Form W-2 comes into play. A W-2 is a Wage and Tax Statement for employees. The form details the employee’s total compensation and all the taxes (including income, Social Security, and Medicare taxes) you withheld from their paycheck during the tax year.
Employees often receive employee benefits as a form of compensation as well. This can include health insurance, paid time off, 401(k) matching, etc. The law also offers certain employee protections, such as minimum wage and overtime regulations.
You must file a W-2 form for all employees who earned at least $600 during the year or those whom you withheld tax, even if you paid them less than $600. Your employees will use their W-2s to file their income tax returns.
What are 1099 workers?
In contrast, 1099 workers are independent contractors, freelancers, or gig workers you hire on a contract basis. These workers are not your employees; they are self-employed.
Instead of a W-2, you’ll report independent contractor compensation on Form 1099-NEC, Nonemployee Compensation. Unlike W-2 employees, you typically won’t need to withhold or pay any federal taxes on payments to 1099 workers. The 1099 contractor will set aside and pay their own taxes, including self-employment tax, every quarter.
Independent contractors don’t generally receive employer-sponsored benefits, and you won’t need to cover additional costs such as unemployment insurance or workers’ compensation for these types of workers.
You must file a 1099 for a worker if you paid them at least $600.
What’s the difference between W-2 employees and 1099 contractors?
The core difference between W-2 employees and 1099 contractors is determining who controls significant decisions. The IRS looks at three factors when deciding how to classify workers:
- Behavioral control: Who determines how the worker does the job? As the company, if you control the worker’s behavior, such as what hours they must work, what tools they use, and where they must be located, the worker will likely be designated as your employee. They are probably an independent contractor if you don’t control these factors.
- Financial control: As a company, do you control how the worker is paid and whether their expenses are reimbursed? If so, the worker is likely an employee. If the worker can make business decisions that affect their bottom line, they might be a 1099 worker.
- Type of relationship: Do you provide the worker with insurance or benefits? Is the worker going to be employed indefinitely? If so, they are likely an employee. If you don’t provide benefits and the relationship is only expected to continue for a specific time period or project, the worker is likely an independent contractor.
Ultimately, the type of worker you should hire depends on your business needs and goals. There is no one-size-fits-all answer. You could even hire a mix of W-2 employees and 1099 contractors if it makes sense for your business.
When should I hire an independent contractor?
There are several factors to keep in mind when deciding if you want to hire independent contractors. Here are some potential reasons to hire a 1099 worker:
- Short-term projects: If you have a project with a defined scope and a precise end date, hiring an independent contractor can be cost-effective. For example, you might hire a freelance graphic designer to create marketing materials for a specific product launch.
- Specialized skills: When you need specialized skills or expertise for a specific task or project, hiring a contractor could be more efficient. One example might be bringing in a cybersecurity expert to conduct a security audit.
- Seasonal work: During seasonal peaks or occasional busy periods, contractors can help manage the workload without the long-term commitment of hiring an employee. This could apply to hiring extra help at a retail store during the busy holiday season.
- Limited budget: If you’re a small business with a tight budget or just starting out, contracting can help you access talent without the financial burden of payroll taxes, benefits, and ongoing salary commitments.
- Variable workloads: For tasks requiring flexibility and varying intensity, such as IT support for occasional troubleshooting, contractors can be a practical choice.
When should I hire a W-2 employee?
When deciding whether you should hire a W-2 employee, consider the following:
- Long-term growth: Do you foresee consistent and long-term growth in your business? If so, hiring full-time employees can provide stability and a dedicated workforce to support your expansion.
- Core business functions: Employees are suitable for roles central to your business’s day-to-day operations, such as customer service representatives, salespeople, or production staff.
- Team integration: If you want workers who are fully integrated into your company culture, share your vision, and work closely with other team members, you might want to look into hiring employees.
- Consistent work: When you have ongoing, regular tasks that require a set schedule, like administrative assistants or customer support agents, W-2 employees can ensure consistent coverage.
- Benefits and training: If you want to offer benefits like health insurance, retirement plans, and opportunities for professional development, hiring employees allows you to provide these perks.
What happens if I misclassify my workers?
Misclassification of workers can lead to legal and financial consequences for your business. For example, suppose you classify a worker as an independent contractor when they should technically be an employee. In that case, you may owe back taxes on top of penalties and interest to the IRS.
If you need to reclassify a contract worker as an employee, the IRS offers a Voluntary Classification Settlement Program that can provide partial relief from federal employment taxes as long as eligibility requirements are met.
Remember to closely follow the IRS guidelines for worker classification to avoid legal or financial repercussions.