You’ve decided you need to bring someone in to help with your business.
You realize you don’t fully understand IRS worker classification rules for employees and independent contractors. Or the difference between a 1099 and W2 form.
Small business owners must successfully navigate the complexities of classifying workers to deliver the appropriate tax forms, 1099 vs W2. The distinction matters for businesses and workers.
This knowledge supports informed decision-making that may better align with your business strategy and goals. It also helps protect you from incurring legal and financial penalties.
Read on to learn more about:
- Independent contract vs employee or 1099 vs W2 pros and cons.
- The 1099 form vs W2.
- Who decides if a worker will be classified as a 1099 contractor or W2 employee?
- Can a worker be both 1099 contractor and W2 employee in the same year?
- What is a 1099 Form used for?
- What happens if I misclassify a worker?
- … and more
What Is a W2 Employee?
The Internal Revenue Service (IRS) generally classifies workers in two distinct categories: W2 employee or 1099 contractor.
Understanding the difference can help a small business avoid significant civil, and possibly even criminal penalties.
The IRS defines an employee as someone the business controls what will be done and how it will be done.
A W2 employee generally works set hours that the employer has approved, and you consider them part of your workforce.
Most small business owners count on employees to contribute to the long-term success and stability of their business.
They also tend to invest in training and development resources to help foster a skilled, knowledgeable, and committed team.
When hiring a W2 employee, a small business owner must get ready for key tasks and financial duties.
Key task categories include payroll management, benefits administration, and adherence to employment laws and federal and state tax regulations.
What you need to know about W2 employment:
- Depending on their employee classification under applicable wage and hour laws, you can pay a W2 employee on an hourly, salary, or other basis.
- You must withhold payroll taxes and Social Security taxes, and Medicare (FICA) from paychecks.
Other obligations include but are not limited to:
- Pay Federal Unemployment Tax Act (FUTA)
- Provide a W-2 tax form at year-end for tax year purposes.
- File a W2 for any employee you pay $600 or more for the year.
- Pay a W2 employee wages and benefits on a regular payroll schedule in compliance with applicable pay frequency laws.
A large variety of workers receive a W2, including those in health care, food service, and many corporate and factory settings.
What Is a 1099 Worker?
A small business may engage a 1099 worker to perform a specific task or project for a defined duration. Overall, they can offer a cost-effective solution when a project demands special skill sets or expertise.
A 1099 worker is also known as an independent contractor or non-payroll worker.
Like W2 employees, small business owners must handle important tasks and financial duties when engaging a 1099 worker.
The IRS considers three broad factors, known as common law rules, when determining a worker’s status as a W2 employee or 1099 worker.
The factors share the element of control that a business exercises over the worker. A business should look at the entire relationship in context versus using a single factor to determine classification.
- Behavioral. Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial. Are the business aspects of the worker’s job controlled by the payer? These include things like how the worker is paid, whether expenses are reimbursed, who provides tools / supplies, and more.
- Type of relationship. Are there written contracts or employee type benefits, including a pension plan, insurance, vacation pay, and more? Will the relationship continue and is the work performed a key aspect of the business?
Here’s a few important considerations related to engaging a 1099 worker:
- Review the IRS common law rules when determining independent contractor status.
- An independent contractor should maintain autonomy over their work, choosing the means, when, and how to complete their tasks.
- A small business owner does not withhold taxes from payments to 1099 workers. Instead, independent contractors manage their own taxes.
- If an independent contractor earns $600 or more during the year, the small business must report contractor payments using the 1099-NEC or 1099-MISC.
- Be sure to clearly define the work you want 1099 to do to avoid any misunderstandings.
- 1099 workers usually set their own rates and define their preferred pay schedule and terms.
Most 1099 workers typically submit an invoice to their client for payment. They may require a portion of the payment up front. They may also bill weekly, monthly, quarterly, or at engagement completion. Make sure you understand—and try to negotiate—payment terms.
A variety of workers depending on the specific working situation may receive a 1099, these workers may include gig workers, consultants engaged for a specific time frame, and certain freelance creatives.
Key Differences Between 1099 Workers and W2 Employees Under IRS Regulations
Understanding the fundamental differences between 1099 workers and W2 employees for tax purposes can help inform staffing decisions. Differences include tax deduction obligations, the nature of the working relationship, work product control, benefits, and more.
The following chart will help those looking to compare the 1099 vs W2. It will also help those wondering, 1099 vs W2 which is better for employee?
Pros and Cons of 1099 vs W2
Like any working arrangement, pros and cons exist for employers, employees, and workers when it comes to worker classification.
Engaging 1099 workers can be a strategic decision for businesses seeking flexibility and cost-efficiency where it aligns with applicable regulations.
A workforce filled with W2 employees can offer more control, flexibility, and stability than a fleet of 1099 workers.
Which is right for your business? For some businesses, a combination may be the best choice.
Pros and Cons for Businesses
If you’re wondering, 1099 vs W2 which is better, you are not alone.
Read on to compare the differences between 1099 workers and W2 employees.
1099 Worker Pros
Flexibility. A 1099 worker can make it easier to manage fluctuating workloads. You can engage 1099 workers for short-term projects or specific skills. This flexibility supports scaling a workforce up or down based on project demands without long-term commitments.
Cost Savings. Typically, you do not have to offer or pay for benefits, taxes, or long-term commitments with a 1099 worker. That could mean money for other business initiatives, like marketing, research, employee development, or other opportunities to enhance growth.
Specialized Skills. A 1099 worker may offer a broader range of expertise and skills on a project basis. Engaging with independent contractors can introduce fresh perspectives and innovative approaches to your business challenges, driving creativity and problem-solving.
1099 Cons
Less Control. By definition, a 1099 classification offers the business limited ability to dictate work processes and schedules. This lack of control can lead to work quality consistency and alignment with your business goals.
Inconsistent Availability. A 1099 worker may not be available when needed due to other commitments. Or they may be unwilling to work late hours or weekends. Dependence on 1099 workers can pose challenges in meeting tight deadlines or handling unexpected project changes.
Tax Compliance. You must ensure proper classification to avoid IRS and other penalties For Misclassifying workers can result in legal and financial repercussions. It's vital to establish clear criteria consistent with applicable laws and regulations and maintain thorough documentation.
W2 Pros
Stability. W2 employees can provide a more stable workforce for ongoing operations. This consistent presence allows for a deeper understanding of your business processes. It can also contribute to customer interaction continuity, which can enhance reputation and trust.
Control. By definition, hiring a W2 employee offers an employer greater control over work schedules, processes, and outcomes. This control enables you to implement strategic initiatives effectively and ensure alignment with your organizational objectives, fostering a unified approach to achieving goals.
Loyalty and Team Culture. Investing in employee development and engagement can contribute to a more motivated workforce.
W2 employees can offer more stability and control, essential for businesses focused on long-term growth and team cohesion. Still, this choice comes with its own set of challenges and considerations.
W2 Cons
Higher Costs. Payroll taxes, benefits, and administrative expenses add up quickly with a W2 employee. These costs can impact your profit margins, requiring careful budget and resource management to maintain financial health.
Less Flexibility. It’s more difficult to adjust workforce size based on project needs with a W2 employee. A workforce of employees can limit your ability to respond quickly to market changes or pursue new opportunities.
Pros and Cons for Workers
People may have options when it comes to being a 1099 worker or W2 employee. They may wonder, is it better to be a 1099 worker or W2 employee? Well, it depends.
Whether someone works as a 1099 contractor or a W-2 employee, each option comes with trade-offs in terms of control, stability, and support. Understanding the key differences can help business owners anticipate worker expectations.
Highlights of 1099 Work
Independent contractors enjoy more freedom over their schedules, rates, and client choices. They also benefit from business-related tax deductions. However, they are responsible for managing taxes, securing benefits, and finding steady work—challenges that can add complexity and uncertainty.
Highlights of W-2 Employment
W-2 employees typically receive a steady paycheck, access to employer-sponsored benefits, and legal protections like overtime and minimum wage. On the flip side, they may face more oversight, limited flexibility, and restrictions on outside work or personal expression, such as social media use.
When to Use 1099 vs W2
Deciding between 1099 workers and W2 employees depends on your business needs, budget, and long-term goals.
A strategic approach to workforce planning can help you align your decisions with your overall business strategy. It comes down to ensuring that you have the right team in place, at the right time, to help achieve your objectives.
Project Scope and Duration
Short-Term Projects. 1099 workers may offer an ideal solution for projects with a clear end date or specific expertise. That allows you to bring in specialized skills as needed, optimizing project outcomes without long-term obligations.
Ongoing Operations. W2 employees may be better suited for roles that require ongoing responsibilities and team integration. They provide consistency, essential for maintaining efficiency and supporting core business functions.
Budget and Resources
Cost Constraints. Engaging 1099 workers may extend your staffing budget. Their engagement can alleviate financial pressures, enabling you to allocate resources more effectively across your organization.
Resource Availability. Ensure you have the resources to manage payroll taxes and benefits for W2 employees. Investing in the necessary infrastructure and systems can facilitate compliance and streamline administrative processes, supporting sustainable growth.
Compliance and Risk Management
Avoid Misclassification. Ensure you understand IRS guidelines and other requirements under applicable laws and regulations related to worker classification to avoid penalties. Regularly review your workforce classifications and stay informed about regulatory changes. This can help mitigate risks and protect your business from legal challenges.
Consult Professionals. Consider consulting with HR and tax professionals to make informed decisions. Their expertise can provide valuable insights and guidance to align your employment strategies with best practices and compliance requirements.
Tax Implications of 1099 vs W2
Significant tax differences exist when it comes to 1099 workers and W2 employees, including:
- Who withholds federal, state, and local (where appropriate) taxes?
- What taxes must be paid, including FICA?
- When taxes must be filed
Business Implications
Tax-related compliance tends to be more involved when paying a W2 employee when compared to a 1099 worker. A small business owner paying a W2 employee must:
- Withhold federal, state, and local (where appropriate) taxes.
- Withhold the employee-paid portion AND pay the employer portion of FICA, FUTA, and State Unemployment Insurance (SUI).
Conversely, payments to an independent contractor typically won’t generate any tax liabilities for a small business owner.
That means all taxes remain the responsibility of the independent contractor.
Instead, the business owner must:
- Correctly classify the workers as an independent contractor under IRS regulations.
- Collect a W-9 at engagement start.
- File a 1099 at year's end if the contractor is paid more than $600.
Worker Implications
An independent contractor bears the burden of payroll and related taxes. An employer handles those taxes for an employee.
Many independent contractors opt to pay quarterly taxes to avoid a large tax bill or a possible underpayment penalty.
An independent contractor may also owe self-employment tax if their work totals $400 or more. This tax is a combination of Social Security and Medicare taxes.
Legal Risks of Misclassifying Workers
The IRS enforces strict classification criteria regarding 1099 workers or W2 employees. Other requirements related to worker classification exist under other federal, state, and local laws.
Misclassifying an employee as an independent contributor can lead to significant financial and legal issues. Including but not limited to litigation, back employment taxes, substantial penalties, and interest.
Conclusion: How SurePayroll Can Help
Who you bring on, the role they play, and how you classify their work impacts your business's financial health.
Take time to understand the differences between a 1099 worker and W2 employee. Then select the option that best aligns with your short-term and long-term business goals.
By evaluating your needs and talking to HR experts, you can better navigate employment classifications. This helps you build a strong, flexible workforce and encourage a culture of innovation and excellence.
SurePayroll® By Paychex can help prepare and file W2 and 1099-NEC forms on your behalf.
Trusted by small businesses and households for more than 25 years, you can count on SurePayroll to provide you with simple, no-nonsense payroll—with no long-term commitment. The easy-to-use SurePayroll platform helps you pay your employees and file your taxes on time, every time.
Learn more today.
