W-2 forms are for employees who work directly for your business with taxes withheld by the employer, while 1099 forms are for independent contractors responsible for their own taxes. Proper classification of 1099 vs W-2 employees ensures compliance with tax regulations and optimizes workforce management.
The IRS Form W-2, also called the Wage and Tax Statement[1], is like a report card for employees. It shows how much money they earned, what benefits they received, and how much taxes they paid during the year.
You need to fill out a W-2 for anyone who worked part-time or full-time for your business during the year, even if they didn’t make much money.
For example, if someone earned $600 or more or if you took out taxes from their paychecks, you must give them a W-2.
W-2 employees are like the backbone of your business. They get a regular salary and benefits, and their taxes are taken from their paychecks. They usually work at your place of business, and their job is essential for your company’s main activities.
On the other hand, a 1099-NEC[2] is a form for people who aren’t your employees, like independent contractors. It’s like a receipt that shows how much money you paid them for their work during the year. If you paid someone $600 or more for their services and didn’t take out taxes from their pay, you’ll need to give them a 1099.
1099 contractors have more freedom in their work; they might get paid for their work hours or for completing a project. Unlike W-2 employees, they must handle their own taxes, including self-employment taxes.
1099 vs W-2 employees
The distinction between 1099 and W-2 workers boils down to this: 1099 contractors are independent workers providing a service, whereas W-2 employees work directly for your business. 1099 contractors provide flexibility and cost savings but require careful tax handling, while W-2 employees offer long-term stability and integration into your company culture.
Once you’ve identified the type of worker you’re hiring, managing tax forms becomes straightforward: contractors complete a W-9 form, while employees fill out a W-4. During tax season, you’ll submit a 1099 for each contractor and a W-2 for each employee.
1- 1099s are often more cost-effective
In many cases, hiring 1099 workers can be cheaper than hiring W-2 employees. You’re not responsible for providing benefits like health insurance, life insurance, bonuses, or retirement contributions.
Plus, you don’t need to worry about training costs, downtime, or worker’s compensation.
However, there are exceptions: Certain professionals, such as salespeople, marketers, and software developers, may charge high hourly rates.
Tip: If their work is essential to your business and they work enough hours, hiring them as W-2 employees could be more cost-effective.
2- 1099s don’t require payroll tax withholding
When you hire W-2 employees, you’re responsible for withholding and remitting payroll taxes, including Medicare, Social Security, and income tax. This usually involves using payroll software or having an administrator handle payroll for you.
On the other hand, with 1099 workers, you just need to pay them and file a 1099-NEC form[3] at tax time. This simplifies the process and reduces administrative burden.
3- 1099s typically have less regulatory burden
Hiring 1099 workers often involves fewer regulatory obligations compared to hiring W-2 employees.
W-2 employees are protected by various employment laws, such as the Fair Labor Standards Act (FLSA)[4], the Occupational Safety & Health Act (OSHA)[5], and Title VII of the Civil Rights Act[6]. In many cases, working with 1099 contractors can be simpler from a regulatory standpoint.
However, there are exceptions.
As companies increasingly opt for 1099 arrangements, government agencies like the Department of Labor[7] and the Internal Revenue Service[8] are intensifying efforts to combat misclassification.
Misclassification occurs when employers treat workers as 1099 contractors but exert control over their work, like W-2 employees.
The IRS views misclassification as tax evasion[9] and may pursue unpaid employer and employee payroll taxes, Social Security, and Medicare contributions. They’ve also been known to investigate individuals who report over $10,000 in 1099 income.
It’s essential to note:
Simply because someone works remotely, signs a contract, or receives a 1099 form doesn’t automatically classify them as a 1099 contractor. According to the U.S. Department of Labor, employers are prohibited from misclassifying employees[10], regardless of any agreements made with the employee.
Tip to remember:
Employers must thoroughly understand the differences between 1099 and W-2 workers before hiring. In case of incorrect worker classification, they may be held liable for unpaid employment taxes, penalties for non-compliance, and interest charges. Additionally, misclassified workers may file complaints or lawsuits against the employer for benefits and protections they were denied due to their misclassification.
4- 1099s offer more flexibility
Ending a working relationship with a 1099 contractor is typically easier, especially if termination clauses are outlined in the contract. This flexibility can be advantageous for businesses with unpredictable employment needs, such as those operating in highly seasonal industries.
Additionally, hiring 1099 contractors allows for immediate project commencement.
In some states, “at-will” employment policies[11] may make it easier to terminate a W-2 employee than a contracted 1099 worker.
Furthermore, as employers have more control over W-2 employees’ day-to-day tasks, they possess greater flexibility to adjust work directions or halt projects if necessary.
5- W-2s offer long-term benefits
While W-2 employees may require initial training and integration into the workplace culture, they often provide long-term value.
Job postings for W-2 positions tend to attract higher-quality applicants who are more inclined to commit to the organization. This commitment enables W-2 employees to focus on tasks without the distraction of seeking alternative employment.
Moreover, building a cohesive team and nurturing a strong company culture is typically more achievable with W-2 employees. Their presence fosters a sense of unity and shared purpose within the organization.
Additionally, as the business grows, having experienced W-2 employees who understand the company’s operations becomes invaluable, particularly for managerial roles.
6- W-2s excel in core business functions
For tasks that are non-essential to your business, hiring a 1099 contractor may offer advantages in terms of cost-effectiveness, speed, and reduced regulatory burden.
However, when it comes to critical functions integral to your business’s core operations—such as marketing, client relationship management, or managerial duties—opting for a W-2 employee often aligns better with long-term goals and work culture priorities.
Examples of 1099 vs. W-2 workers
Understanding whether someone is a 1099 contractor or a W-2 employee can sometimes be tricky. If you’re unsure how to classify your workers, getting advice from a business or labor attorney is a good idea.
Here are some examples to help clear things up:
Examples of 1099 workers
- A freelance writer who works on projects as needed, without set hours.
- Consultants brought in for a specific project with a clear start and end date.
- Gig workers who use apps to provide services are paid per task (though rules may vary by state, like in California).
- Freelance designers and developers who work on individual projects.
Examples of W-2 Employees
- Staff writers with regular hours, whether they work from home or in the office, and ongoing tasks.
- Project managers with consistent workloads and regular team meetings.
- Delivery drivers with set hours and routes, using company vehicles or branded materials.
- Staff designers or developers with scheduled hours, whether they work remotely or in the office, and ongoing tasks.
These examples provide a basic understanding of the difference between employees and contractors, but remember that proper classification can depend on many factors, which may vary by state[12].
How to decide who to hire?
1. Calculate the hours needed
Start by figuring out how many hours you need the person to work each week. Different organizations define “full-time” differently. For the IRS, it’s over 30 hours a week[13], while the U.S. Bureau of Labor Statistics says it’s over 34 hours[14].
If you need someone for more than 30 hours a week, it’s best to hire them as a W-2 employee. On the other hand, for short-term positions lasting a few months or less, hiring a 1099 contractor might be more suitable.
2. Determine your budget
Once you know how long you need the person to work, consider how much you’re willing to pay them. While 1099 contractors may charge higher hourly rates, W-2 employees come with benefits that can make them more cost-effective over time.
Compare the costs of hiring each option—hourly 1099, per-project 1099, and hourly W-2—and choose the most economical one.
3. Consider remote or in-person work
Lastly, decide whether the person needs to work remotely or in the office. If the position doesn’t require close collaboration with others and isn’t crucial to your business, hiring a 1099 contractor for remote work might be suitable.
However, if the work involves collaboration or is essential to your business operations, hiring them as a W-2 employee might be more beneficial, even temporarily.
The bottom line
Effectively managing 1099 and W-2 workers is essential for maintaining compliance and optimizing your workforce, but handling these forms and ensuring compliance with tax regulations can be complex.
That’s where CoCountant comes in.
Our comprehensive accounting services for startups and small businesses include payroll and 1099 support, invoicing support, and expense management to ensure accurate documentation and compliance with both tax regulations and labor laws. This allows your business to confidently manage both types of workers, streamline payroll processes, and focus on growth without letting this part of workforce management complexities confuse you.
FAQs
What is 1099 vs W2?
1099 form reports income other than wages, salaries, and tips. It is typically used to report income earned as an independent contractor, freelancer, or self-employed individual. There are different types of 1099 forms, such as 1099-MISC (for miscellaneous income), 1099-INT (for interest income), 1099-DIV (for dividend income), and so on. If you receive a 1099 form, you’re responsible for reporting that income on your tax return and paying any applicable taxes on it.
The W2 form is used by employers to report wages paid to employees and the taxes withheld from those wages over the course of a calendar year. It includes information such as total wages earned, federal and state income taxes withheld, Social Security and Medicare taxes withheld, and other deductions like contributions to retirement plans. Employees use the information from the W-2 form to fill out their individual tax returns.
What are the benefits of 1099 vs W2?
Benefits of Being a 1099 Independent Contractor:
- Ability to set own schedule and choose clients.
- Opportunity for higher pay rates and entrepreneurial ventures.
- Eligibility to deduct business expenses, reducing taxable income.
- Exposure to diverse projects and clients, fostering professional growth.
Benefits of Being a W-2 Employee:
- Access to employer-sponsored benefits like health insurance, retirement plans, and paid time off.
- Consistent paychecks with taxes automatically withheld.
- Covered by labor laws regarding minimum wage, overtime pay, and workers’ rights.
Is 1099 only for US citizens?
No, the 1099 form is not only for US citizens. It is used by businesses in the United States to report various types of income paid to individuals, including non-citizens who may be resident aliens or non-resident aliens. If a non-citizen earns income from a US source, they may be subject to US tax laws and receive a 1099 form to report that income to the IRS.
