1099 vs W2: What’s the Difference?

When it comes to different types of workers, many people don’t realize that there is more than one type. In fact, each different type of worker has their own set of guidelines when it comes to how they work, how they deal with taxes, and more. It’s important to understand different types of workers that are available because it can impact business aspects that can make or break a small business owner. Two popular types of workers are W2 employees and 1099 workers. In this article, we will go over what these two options are, their differences, and how to choose the best one for your business.

What is a W2 Employee?

Let’s start off by talking about W2 employees. This is what most people think about when work comes to their mind. Also known as payroll employees, these employees are typically the “default” when it comes to workers. The pay for these employees is typically at an hourly rate and they have a specific job that they need to do. Once hired, W2 employees typically work indefinitely until they quit or get fired. However, W2 employees have protections thanks to employment laws so if an employee is terminated it must not violate any protections they have.

The role that an employee will handle depends on what the company they work for determines. Companies control how and when the work gets completed by employees which gives the company full control! However, since companies have the say on how the work gets completed, they have the responsibility to provide training and tools for employees to use on the job.

It’s important to keep in mind that with W2 employees, they have basic employee benefits that they are entitled to like minimum wage, overtime protection, etc. Some other employee benefits that companies may offer (besides the basics like minimum wage) includes health insurance, vacation time, retirement plan contributions and more.

Now onto the tax side of things. When you think of a W2 employee, they are a payroll employee. That means a business owner will need to pay payroll taxes. Payroll taxes are taxes paid on the wages and salaries of employees. This includes medicare taxes, social security taxes, etc. The taxes paid are at a 50/50 split between the W2 employee and the employer.

What is a 1099 Worker?

Now that you know what a W2 employee is, you can learn about 1099 workers (also known as 1099 employees). When you think of a 1099 worker, you may automatically think of an independent contractor. Instead, there are multiple different types of workers that can be a 1099 like a freelancer, consultant, etc. However, one of the more popular options is an independent contractor. When a business owner is considering their options, this is a popular choice because these types of employees typically cost 30% less to hire.

On top of that, these employees are not protected by legislation so that means that there is no requirement for employee benefits or even employment taxes. That’s because 1099 workers like an independent contractor pay employment taxes on their own (known as self employment tax). This would include the standard medicare taxes, social security taxes, etc. Except the difference is that the employer will not have to worry about splitting them 50/50 like with payroll taxes since the employee handles all of them on their own!

1099 vs W2: What’s the Difference?

Now that you understand the basics of each type of worker, it’s time to compare the difference between a 1099 vs W2 employee. Let’s start off by understanding the difference and then we can get a deeper look at the pros and cons for each option when it comes to hiring them. There are some main differences to consider when comparing a 1099 vs W2 worker. The biggest differences are:

  • Employee Protections
  • Employment Taxes

Employee Protections

W2 employees are the ones that have some of the most protection. That’s because there are labor laws that specify employment protections. For example, there is the Fair Labor Standards Act (FLSA) that requires the federal minimum wage and specifies that it is $7.25, talks about overtime protections, and more.

On the other hand, 1099 workers don’t have these protections. That’s because labor laws like the FLSA don’t apply to this type of worker since they are technically not considered employees. In fact, there are plenty of people that may face a lack of protection from labor laws like:

  • Employees at businesses that have less than 2 employees
  • Apprentices
  • Some agriculture workers
  • Employees at businesses that have less than $500,000 in revenue every year that do not take part in interstate commerce

Employment Taxes

Besides employee protections, the taxes play a big role in understanding the difference between a 1099 vs W2 worker. That’s because W2 employees are responsible for payroll taxes. That means taxes like medicare taxes (amongst others) are split 50/50 between the employee and the employer.

On the other hand, 1099 workers like an independent contractor are responsible for self-employment tax. This leaves the worker responsible for 100% of the taxes instead of leaving any responsibility to the employer.

How to Tell a 1099 vs W2 Worker Apart?

Now that you understand some of the differences a bit more between these two types of workers, you will want to make sure you can tell them apart. It can be a little tricky, especially since they may do some similar tasks in the business. However, the Internal Revenue Service (IRS) understands that it can be hard for business owners to figure this out. That is why they have an online source that may be able to help people understand the difference when classifying their workers.

We want to remind you that even though there are resources online that can help you understand what type of employee you are dealing with, the best way to determine this is by speaking to a professional. A professional like a tax advisor, a business consultant, or even the IRS directly can help you properly classify your workers. Now that we got that out of the way, let’s focus on some “common law” rules that apply to understanding workers which are:

Behavioral Control

This factor can help an employer identify their workers. That’s because the behavior allowed for a worker will depend on the type they are. Some factors of behavioral control include types of instructions given, the level of instruction, evaluation systems in place, and the training. Each of these factors of behavioral control can impact how they are classified. Let’s take a deeper look!

Types of Instructions Given

A W2 employee can expect to be subject to business instructions about how, when and where to work. For example, giving instructions on what tools to use, what workers can help, when to do the work, where to do the work, what equipment is involved, where to get supplies, where to find services, what work will need to be done by someone specific, etc.

The Level of Instruction

Think about it like this, if you are providing in-depth and detailed instructions, then you are likely trying to exercise more control over the worker. As a general rule of thumb, the more detailed the instructions then the higher the chance that the worker is considered a W2 employee. When a worker is more independent (hint hint: like an independent contractor which is a 1099 worker) then they will typically have less detailed instructions.

Evaluation Systems in Place

When you have systems in place that can measure how the work is done by a worker then you may be dealing with a W2 employee. However, any evaluation system doesn’t automatically point to a W2 employee. Instead, there can be evaluation systems that measure aspects like the end result which could show that the worker is a 1099 worker like an independent contractor.

The Training

Think of 1099 employees as people that already come in with a certain level of expertise. That means that they shouldn’t need much training in order to help you accomplish the goals you have for their role. However, if the business gives training on how to do the job, what’s required to do the job, etc., then that can show that the business expects the work to be done a specific way. When there is too much control, then that can be proof of a W2 employee.

Financial Control

Now that you understand the behavioral factor that goes into determining the type of worker you are dealing with, let’s move onto the financial factor. The financial side of things looks at the control that a business has when it comes to the economics of the worker’s job. Some factors of financial control include investments, unreimbursed expenses, and method of payment.

Investments

When it comes to the investment factor, it needs to be significant. That’s because generally a 1099 worker like an independent contractor will have to put a significant investment towards equipment they use. There is no dollar amount rule when it comes to this factor but it is still something to be aware of.

Unreimbursed Expenses

It’s not uncommon for a 1099 employee like an independent contractor to rack up expenses that need to be reimbursed. That is why if there are a lot of unreimbursed expenses then you may be dealing with when you have a 1099 employee. However, it’s also important to note that unreimbursed expenses are not exclusive to 1099 employees. That’s because a typical W2 employee could still rack up unreimbursed expenses in connection to the job they perform for their employer.

Method of Payment

Another factor to consider is the method of payment. That’s because typically a W2 employee is usually paid at an hourly rate. However, they could be paid by other time increments like a weekly rate, or any other period of time rate. On the other hand, a 1099 employee like an independent contractor is usually paid with a flat fee but they can also be paid hourly as well.

Type of Relationship

Last but not least of the “common laws” is the type of relationship that the employer has with the employee. It can be confusing understanding the relationship between these two parties but can be easier to understand when you consider factors like written contracts, benefits for the employee, permanency of the relationship, and whether or not the services provided are a key part of the business.

Written Contracts

Even if the written contract specifies the type of employee, that is not all the IRS will use to determine if that’s actually the case or not. Instead, the details in the written contract like how both parties will work together is what the IRS would look at to determine the type of worker.

Benefits for the Employee

Like we said earlier, 1099 employees are not protected by labor laws which means benefits like overtime protection, workers compensation insurance etc. are typically not provided. Other benefits like health insurance, pension plans, paid vacation, sick days, and more also are examples of benefits that a 1099 employee typically doesn’t get.

Permanency of the Relationship

When hiring a 1099 worker, employers usually hire them for a specific period or even for the time it takes to complete a project. However, if the worker is hired and expected to continue indefinitely, they would likely be considered a W2 employee.

Services Provided

If a worker handles services that are an important part of day-to-day activity then it is likely that the company will have a certain level of control over these tasks. If they have a level of control that’s too much, then that would likely be an example of a W2 employee and employer dynamic.

1099 vs W2: Which is Better to Hire?

The best option for you to hire will depend on your exact situation. That is why you would want to talk to a professional. A good way to compare your options is by looking at both the pros and the cons that come along with the different types of workers.

Pros of 1099 Workers

A few of the benefits include:

  • Tax Benefits
  • More Affordable Business Expenses
  • Reduced Legal Risk

Tax Benefits

We may sound like a broken record but there are some serious tax benefits that employers get when they choose to hire a 1099 worker. That’s because these workers will handle the cost of all the taxes with their self-employment tax. Employers get to benefit off the fact that they don’t have to worry about splitting tax responsibility like with payroll taxes.

More Affordable Business Expenses

On top of the fact that 1099 employees handle 100% of the taxes that they need to deal with, there are also less business expenses due to the lack of benefits. Without having to provide insurance, overtime protection, etc., employers don’t have to worry about that cost. That results in less business expenses which is more affordable for employers! In fact, hiring a 1099 worker is generally 30% less expensive for employers.

Reduced Legal Risk

Last but not least on this list of pros that come along with a 1099 employee is the reduced legal risk that employers face. That’s because 1099 workers do not have protection from labor laws. Besides that fact, typically these types of workers can have a hard time being able to file wrongful termination claims. This results in a reduced legal risk for the employer.

Cons of 1099 Workers

Now that you understand some of the pros that come along with this type of worker, is it now time to learn about the flipside which are the cons. Some of the cons that come along with this type of worker includes:

  • Not as Much Control
  • There Needs to be a Solid Agreement
  • Potentially Deal with Government Audits

Not as Much Control

Think back to how the IRS defines a W2 employee. One of the biggest factors relates to the level and type of control that employers have. That means 1099 workers require an employer to have less control.

There Needs to be a Solid Agreement

You want to make sure that the agreement that you have with your 1099 worker is air tight! That’s because if an employer breaches the contract, it can lead to issues. For example, there may be limitations around terminating a 1099 worker and if those limitations are broken by the employer, that would be a breach of contract.

Potentially Deal with Government Audits

Dealing with audits can happen whenever. However, employers that have 1099 workers may deal with them more because agencies aren’t exactly happy about a lot of 1099 workers. Why? Well because as a W2 employee it is easier for agencies to track and monitor money. This monitoring makes it hard for people to try to hide their income! Some agencies that may try to conduct an audit include:

  • Occupational Safety and Health Administration
  • National Labor Relations Board
  • IRS
  • Your State’s Unemployment Compensation Agency
  • Your State’s Workers’ Compensation Agency
  • United States Department of Labor
  • Your State’s Tax Agency

Pros and Cons of W2 Employees

After learning about the pros and cons of 1099 workers, you will want to make sure you understand the pros and cons of W2 employees. Some of the pros include:

  • Higher Level of Control
  • Possibly Better Productivity

On the other hand, some of the cons include:

  • More Expensive
  • More Taxes

Pro: Higher Level Of Control

Unlike 1099 workers, there is no limit to how much control a company can have when it comes to the work of their employees. The employer can dictate how the work is done, when it is done, what equipment will be used to accomplish it, etc.

Pro: Possibly Better Productivity

Since W2 employees can benefit from overtime protection, workers compensation insurance, etc., they may be more productive than someone that doesn’t get those benefits. It is a good way to provide incentives especially if the employer provides additional benefits like matching retirement contributions, paid vacation time, etc.

Con: More Expensive

Since W2 employees can get benefits and protections from labor laws, it costs more money to handle that. For example, if a company provides health insurance coverage, then they will need to deal with that expense for all their employees.

Con: More Taxes

Unlike 1099 employees that have self-employment tax that they need to deal with, W2 employees only need to deal with half that amount. That’s because the taxes they are responsible for are split 50/50 with the employer.

Commonly Asked Questions

Understanding the difference between a 1099 vs W2 worker can be confusing for a lot of people. That is why there are commonly asked questions that others have had when learning about this topic. These questions may be some that you have after reading the information above!

Do 1099 Workers Pay More Taxes?

Since 1099 workers are seen as self-employed, they have a self-employment tax rate. This self employment tax rate is 15.3% overall. It consists of two parts which are:

  • 12.4% for Social Security
  • 2.9% for Medicare

Individuals that are 1099 workers are responsible for 100% of these taxes. The same tax rate applies for W2 employees of 15.3% overall (which is 12.4% for Social Security and 2.9% for Medicare). However, they are split up differently. W2 employees would be responsible for:

  • 6.2% for Social Security
  • 1.45% for Medicare

The other 6.2% and 1.45% is the responsibility of the employer!

As an Employer, Do You Need to Pay Income Taxes for 1099 Workers?

No! Employers do not need to pay income taxes for 1099 workers. Instead, 1099 workers are responsible for their self-employment tax and income tax on their own.

Is an Independent Contractor a 1099 Worker or a W2 Employee?

An independent contractor is an example of a 1099 worker.

Will an Employer Withhold Income Taxes?

Employers have the responsibility of withholding employment taxes from their employees which includes federal income taxes.

Overall

A W2 employee is what most people think of when it comes to a standard worker. This is a different type than a 1099 worker. Some key differences between these two options comes down to how they handle protections, and taxes. It can be a little tricky telling them apart. Some ways that you can are to look at factors like:

  • Behavioral Control
  • Financial Control
  • Type of Relationship

We want to remind you that even though there are resources online that can help you understand what type of employee you are dealing with, the best way to determine is by speaking to a professional. A professional like a tax advisor, the IRS, or a business consultant can help you properly classify your workers.

Article References

https://www.stoketalent.com/blog/difference-between-w2-and-1099/

https://taxfoundation.org/what-are-payroll-taxes-and-who-pays-them/

https://smallbusiness.chron.com/costs-employee-vs-independent-contractor-1077.html

https://www.dol.gov/agencies/whd/minimum-wage

https://hrdailyadvisor.blr.com/2020/10/27/who-is-not-covered-by-the-flsa/

https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee

https://www.irs.gov/businesses/small-businesses-self-employed/behavioral-control

https://www.irs.gov/businesses/small-businesses-self-employed/financial-control

https://www.irs.gov/businesses/small-businesses-self-employed/type-of-relationship

https://www.qwick.com/blog/benefits-1099-vs-w2/#benefits

https://www.completepayrollsolutions.com/blog/w2-vs-1099

https://www.nolo.com/legal-encyclopedia/pros-cons-hiring-independent-contractors-30053.html

https://www.irs.gov/businesses/small-businesses-self-employed/self-employment-tax-social-security-and-medicare-taxes

https://www.irs.gov/taxtopics/tc751

https://sharedeconomycpa.com/blog/estimating-income-tax-for-1099-independent-contractors/

https://www.irs.gov/payments/tax-withholding

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