Growing your team is exciting. Adding new workers can grow your business’ profits. But which is the right decision for your business, adding 1099 contract workers or W-2 employees? It’s important to know the differences between each type of worker because there are severe penalties from the IRS and the Department of Labor for getting it wrong. It’s estimated that as many as 20% of businesses have misclassified at least one of their workers.
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What is a 1099 Worker?
It’s an important distinction that businesses do NOT refer to 1099 workers as employees. Employees have different rights and expectations compared to 1099 workers. With each 1099 worker, your business must report their compensation on a Form 1099-NEC once you’ve paid them at least $600 for their services.
Other names for 1099 workers include:
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independent contractor
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freelancer
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gig worker
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self-employed individual
These 1099 workers are business owners, even if they are a one-person business. They are providing a service to your company. They are not on your company’s payroll.
What is a W-2 Employee?
A W-2 employee is a person for whom you’ll report their wages and compensation using a Form W-2. The W-2 will show the withholdings you made from the employee’s pay. Your employees will use the W-2 form for their tax reporting. A W-2 employee can be either part-time or full-time.
What is the Difference Between 1099 Vs. W-2 Employees?
The most important point to understand as a business owner is that you can’t simply decide to call someone a 1099 worker when their work would be classified as that of an employee. The IRS makes the classification rules. The IRS lists what it calls Common Law Rules. These rules ask you about the degree of control you have over the person’s work and the amount of independence the worker has when completing their tasks.
Behavioral: Does the company control how the worker does the job?
The more aspects of the person’s job you control, such as schedule, location, tools to use, methods, etc., the more likely this person must be classified as your employee.
Financial: Do you control business aspects of the worker’s job?
This can include how the worker is paid, reimbursement for expenses, providing them with tools, and whether or not they can work for competitors. The closer you get to treating this worker as your employee, the less likely you are allowed to classify this person as a 1099 contractor.
Type of relationship: Do you provide benefits typical of an employee, such as Paid Time Off, insurance, etc.? Is the job expected to last indefinitely?
A contractor typically is hired for a project. An ongoing project with no end date and giving the person other benefits signals to the IRS that this person most likely should be classified as an employee.
Remember, just because you tell a worker that they are an independent contractor doesn’t make it legally so. The IRS decides. The IRS examines the working relationship to see how it falls under its rules. Another way to think about 1099 vs. W-2 employees is the amount of control you have over them.
With a W-2 employee, you:
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Have the right to dictate how the work is to be done
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Provide the tools, training, and equipment
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Set their hours and schedules
With a 1099 independent contractor, you:
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Control the result of the work, not how it is done
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Do not dictate methods for completing the work
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Do not provide tools
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Do not control their work schedule
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Allow them to provide similar services to other businesses
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Allow the worker to accept or turn down your work opportunities
Examples of 1099 vs. W-2 Workers
Consult a business or labor attorney to help you classify your workers correctly. The following examples are for general guidance only. Your state or municipality may have additional rules for determining whether or not a person should be classified as a 1099 or W-2 worker.
Examples of 1099 Workers
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Freelance graphic designers, video editors, and writers who work on a per-assignment basis rather than set hours
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Project consultants with a clear start and end date
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Web developers who work on an assignment or project basis
Examples of W-2 Employees
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Graphic designers, video editors, and writers with scheduled hours and ongoing work
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Project managers with regularly scheduled team meetings and no defined end date to the work
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Web developers with scheduled hours and ongoing work
1099 Vs. W-2 Employees, Which Type Is Best for Your Business?
Many small businesses start growing by hiring 1099 contractors. The reason is that 1099 independent contractors can be less expensive, especially when you only need help with specific projects.
For instance, if your small business would like to create a website, it might make more sense to hire an independent contractor for this one-time project rather than hire a W-2 employee, because you might have nothing for that employee to do after the project is complete.
A big potential downside of hiring a 1099 independent contractor is that this person is allowed to turn down assignments. Typically, your W-2 employee understands they are expected to agree to complete assignments that fall under their job description. A 1099 contractor can simply say no to your project because they don’t like the project, or they are too busy, or for any reason whatsoever.
Another potential downside of hiring 1099 independent contractors instead of W-2 employees is that you don’t get to have the same control over the worker’s time and methods. For instance, if you hire a bookkeeper who is a 1099 independent contractor, you can’t require that person to work from 9 to 5 and use the software you want.
It makes sense to hire a W-2 employee (whether part-time or full-time) when you:
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Expect to have ongoing work for the role
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Want the worker to follow your company’s rules
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Want the worker to use your company’s equipment
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Want the work completed during scheduled hours or in a specific location
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Want the worker completely available to you during certain hours
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Anticipate you’ll need to manage or train the worker
Penalties for Misclassifying W-2 Employees and 1099 Contractors
Even if it’s done accidentally, misclassifying your workers as 1099 independent contractors when, in actuality, they should be W-2 employees can be devastating to your business. For instance, KL Farms/Fire LLC, based in Oregon, misclassified firefighters and truck drivers as independent contractors. The result was a $181,561 penalty.
These workers were mislabeled as independent contractors, but the business had control over their schedule. This misclassification led to a failure by the business to pay proper overtime wages, violating the federal Fair Labor Standards Act (FLSA).
Employers and executives who violate FLSA laws face not only the liability for back wages but also criminal penalties. Business owners may also face penalties for failing to withhold and remit state and federal payroll taxes, failure to make Social Security and Medicare tax payments, and more when misclassifying workers as independent contractors when they are legally required to be classified as W-2 employees.
Moving Forward
When considering 1099 vs. W-2 employees, decide how much control you need to have over the worker. The more you control the worker’s schedule, tools, methods, and ability to decline assignments, the more likely it is that the worker must be classified as a W-2 employee according to IRS rules.
W-2 employees are entitled to FLSA protections such as overtime pay, whereas 1099 independent workers operate as separate entities that perform contract work for your business at an agreed-upon price. Misclassifying workers can result in severe penalties. Avoid these mistakes by consulting with a labor attorney or the HR experts here at Asure.