When you are a business owner, there are a lot of parts that you will need to manage. One important piece of your business is your workforce. Many people don’t realize that there is more than one type of worker! The type of worker you have will impact more than you think, especially when it comes to how your company handles taxes. Many small business owners find themselves considering a 1099 employee, due to some benefits that come along with this type of worker. However, before you make any decisions yourself, you will want to look at your options and understand what’s out there! In this article we will go over a 1099 employee, w2 employee, and how these different workers can impact small business owners.
Different Types of Employees
Let’s start off by making sure we understand the different types of employees that you can hire. There are:
- Payroll Employees (W2 Employees)
- Non-Payroll Workers (1099 Worker)
However, you can commonly see 1099 workers be referred to as 1099 employees. So just make sure you understand the difference even if you see the name used interchangeably.
What is a Payroll Employee? (W-2 Employee)
Let’s start off with the common type of employee that comes to mind for most people when they think of employment. A W-2 employee is essentially the default worker. That means that they are generally hired at either an hourly rate or salary in order to perform a specific job. These employees are hired basically indefinitely as long as their role needs to be performed. Employees have the option to resign or they may be fired by their employer for a variety of different reasons. However, these employees have protections thanks to laws so there are legal guidelines around why an employee can be fired.
Companies are the ones that determine how and when the work is completed by employees. That means companies have total control over the schedule and methods! However, they also need to help the employees as well by providing tools and training in order for them to complete their work.
Employers face rules around this type of employee. For example, they must provide some employee benefits like minimum wage, overtime protection, paid time off, workers compensation insurance, etc. Besides some of the minimum employee benefits that a company must offer, they also have the option to choose to provide even more benefits. This can include retirement plan contributions, child care services, and more.
When it comes to the tax side of things, companies will withhold employment taxes from the employees’ pay. The employer will have to pay income taxes, medicare taxes, and social security taxes at a 50/50 split with the employee.
What is a Non-Payroll Worker? (1099 Worker)
Now that you have a better understanding of the default worker, let’s talk about 1099 workers! This can be one of the more affordable options for business owners to consider. That’s because without overhead costs like employee benefits that come along with W2 employees, it typically costs 30% less to hire these workers. Why is it cheaper? Well W2 employees have protections from the law while 1099 employees don’t. On top of that, companies do not need to handle as much taxes. That’s because when they would normally split employment taxes with a W2 employee, they don’t have to do that with a 1099 employee.
Instead, 1099 workers have self-employment taxes that they need to pay. That means they are responsible for 100% of their own taxes. Self-employment taxes cover social security taxes, medicare taxes, and income taxes. There are a variety of different 1099 workers (which are also known as self employed workers). Each option has their own specifics when it comes to work. Some popular self-employed workers would be:
- Independent Contractor
Individuals that have a high level of expertise in their field are consultants. Their expertise can help companies that bring them onboard because they can provide a level of specialized insight that most people cannot get.
This is probably a title that you have heard recently because freelance work is getting more popular. Freelancers are self-employed individuals that decide the projects they want to work on and the rates they will charge. Typically that means that they are paid by hour or by project and tend to work with many companies at once.
An independent contractor is very similar to a freelancer. That’s because an independent contractor can decide their work and how they are paid. However, they typically work on longer-term assignments with a limited number of clients (like one or two). That means an independent contractor may not work as many jobs or projects as other 1099 workers on this list.
1099 Employee vs W2 Employee: Which is Better for Your Business?
Now that you understand the basics that come along with these employees, it is time to consider what that means for you and your business. That’s because each type of worker comes with its own set of pros and cons that you need to be aware of. Not every type of worker will be best for every business. For truly accurate advice, you will want to get in touch with a professional like a business consultant. However, we will still go over these differences so you can get a better idea of what you will need to keep in mind!
Pros of a 1099 Worker
Let’s start off with the benefits that come along with a 1099 worker. Some benefits include:
- Tax Benefits
- Fewer Business Expenses
- Less Legal Risk
Let’s start off with one of the biggest benefits on this list which are the tax benefits. Typically, employers can expect to withhold taxes on W2 employee paychecks, and be responsible for additional taxes. However, a 1099 worker will be responsible for their own taxes. That means they are responsible for all of their taxes thanks to self-employment tax. Not having to split the tax responsibility 50-50 can mean a lot when it comes to business expenses.
Fewer Business Expenses
Since we are talking about business expenses, let’s dive into this benefit as well! Hiring a 1099 worker can mean having fewer business expenses to deal with. Think of it like this, W2 employees have protections and requirements around work benefits that an employer must provide. However, a 1099 worker does not have those protections. That means as an employer, you will not need to pay for benefits like health insurance, overtime, minimum wage, etc. Besides being more cost effective, it also means less paperwork!
Less Legal Risk
Since 1099 employees are not protected by any work laws, then that means employers deal with less legal risk. For example, an employer will not need to deal with worker’s compensation premiums for an independent contractor. The best part? It’s not uncommon for 1099 employees like an independent contractor to have their own insurance and oftentimes can’t file wrongful termination claims.
Cons of a 1099 Worker
Besides some nice benefits that come along with this type of worker, there are some drawbacks that you need to keep in mind as well. Some of the drawbacks include:
- Less Control Over Workers
- Must Have a Solid Agreement
- Potential Government Audits
Less Control Over Workers
Typically, a W2 employee is the type of worker that you can closely manage. However, a 1099 worker can be a little different. That’s because they have a certain level of flexibility when it comes to deciding how to accomplish the task that you hired them to complete. If you as an employer interferes too much then you run the risk of having your 1099 worker become a W2 employee. If you want control then a 1099 worker may not be the best option.
Must Have a Solid Agreement
When you hire a standard employee like a W2 worker then you have more flexibility when it comes to being able to terminate someone. However, there can be limitations around termination when it comes to a 1099 worker. If your termination of a 1099 worker violates your agreement then that could be a breach of contract.
Potential Government Audits
Since it’s not uncommon for the government to conduct an audit, it is something that you need to be aware of, especially when it comes to your employees. That’s because state agencies and federal agencies want to see more workers classified as W2 employees, not 1099 workers. Why do they care? Well because if more workers are considered W2 employees then the more tax and insurance money can be monitored by the government. This makes it harder for people to try to hide their income from the Internal Revenue Service (IRS).
There may be audits if an agency thinks that you have misconsidered your W2 employees as 1099 workers. Some agencies that may try to conduct an audit includes:
- United States Department of Labor
- National Labor Relations Board
- Occupational Safety and Health Administration
- Your State’s Unemployment Compensation Agency
- Your State’s Workers’ Compensation Agency
- Your State’s Tax Agency
Pros of a W2 Employee
Now that you understand the pros and cons that come along with a 1099 worker, it is time to learn about the pros and cons of a W2 employee. Let’s start off with the benefits! Some benefits that come along with this type of worker includes:
- More Control
- Potentially Better Productivity
The biggest benefit on this list is the fact that an employer has more control with this type of employee. As an employer, you have the right to determine how the work will get done. You get to choose their schedules, and provide the tools they need in order to accomplish the task.
Potentially Better Productivity
When you hire a W2 employee, you will have to provide a variety of different employment benefits like overtime pay, health insurance, etc. That means that individuals that receive these benefits may be more likely to be productive and stay in the position long-term!
Cons of a W2 Employee
Even though there are some benefits that can come along with hiring a W2 employee, there are still drawbacks to keep in mind. Some drawbacks include:
- Higher Cost
When you hire a W2 employee, even though the hourly rate may be less than a 1099 worker, you make up for the costs in other ways. You must provide employee benefits which can take a toll on your finances. Besides benefits, you will need to split how much you pay on employment taxes with your employees. That is why hiring a 1099 worker is about 30% cheaper.
Another drawback when it comes to hiring a W2 employee is the taxes. That’s because with this type of worker you need to split how much you put towards taxes. When you have a 1099 worker, they handle 100% of their own taxes. However, you will need to split the employment tax obligation 50/50 with your W2 employee.
How to Tell If Your Employee is a 1099 or W2?
It is important that you understand the different ways to tell whether or not your employee is a 1099 or W2. The best way to learn the difference is by checking out the fact sheet that the IRS provides. Determining what type of worker you have is known as worker classification. It is important because it shows the IRS whether or not an employer must withhold income taxes, and pay other taxes like medicare, social security, and unemployment tax on wages paid to an employee.
A good rule of thumb to keep in mind is that a worker is considered a 1099 worker if the person that hired them has the right to control or direct the result of work that they produce. However, the employer must not determine what will be done and how it will be done in order to accomplish that result. It can be hard to classify your worker but it doesn’t have to be. There are ways that you can get help deciding! You can break it down into three different areas that you need to consider which are:
- Behavioral Control
- Financial Control
- Relationship with the Worker
If the employer has the right to direct and control the work performed by the worker then they will be considered a W2 employee. Some categories of behavioral control are:
- Instructions Given: For example, instructions like where to work and when to work, the tools to use, etc. Having too detailed of instructions as well can be another indicator. If a worker receives in-depth instructions like these, they may be a W2 employee.
- Evaluation Systems: If there are evaluation systems that detail how the work is done then that may indicate an employee. However, you can still have evaluation systems like ones that determine the end result! In this case, your worker may be a 1099 employee.
- Training: If you need to train the worker then that should be a strong indicator that they are a W2 employee because they do not come in with their own methods/knowledge.
Besides behavioral control, there is financial control that you need to consider. If your business has the right to control or direct the financial and business aspects of the worker’s job then they are likely a W2 employee. Some financial aspects to consider include:
- Unreimbursed Expenses: Typically a 1099 worker will rack up unreimbursed expenses that a company needs to repay (not a W2 employee).
- Opportunity for Gain or Loss: Generally 1099 workers have this opportunity.
- Method of Payment: Typically an employee is guaranteed a wage on an hourly, weekly, or other time basis. On the other hand, a 1099 employee is often paid a flat fee.
The relationship between an employer and a worker is also important to consider when determining the worker classification. Some relationship aspects to consider include:
- Benefits: If your worker is receiving benefits like overtime pay, health insurance, etc., then you are likely dealing with a W2 employee.
- Length of the Relationship: If this business relationship is seen to be ongoing then it may be an example of a W2 employee. On the other hand, if it is expected to only be set for a specific project or period then it may be a 1099 employee.
- Contract: The contract should specify the type of employment and can even include why it was determined in that way.
- Services Performed: The extent of services performed and whether or not they are a key aspect of the standard practices of the company can be an indicator of your type of employee.
Commonly Asked Questions
Understanding different types of employees and which is better for your business can be confusing. Other small business owners learning about the topic had questions along the way. Maybe they even had some of the same questions that you currently have after reading this article as well!
What Qualifies as a 1099 Employee?
The exact qualification will vary depending on your situation. However, 1099 workers are typically a type of worker that works on projects that do not require constant presence. Generally, these kinds of workers are only hired for short-term or long-term projects but it is a position that doesn’t have a fixed schedule or full-time working hours. We might sound like a broken record but we want to remind you that every situation is different. So the best way to determine what qualifies as a 1099 employee would be to get in touch with a professional like a tax advisor.
Is a 1099 Worker an Independent Contractor?
Yes! A 1099 worker can be considered as an independent contractor. There are a variety of different 1099 workers (which are also known as self employed workers). Each option has their own specifics when it comes to work. Some popular self-employed workers would be:
- Independent Contractor
How Much Income Tax Will You Have to Deal With?
If you have a W2 employee then you can expect to pay taxes. You will need to pay taxes like medicare taxes, social security taxes, etc. On the other hand, if you have a 1099 worker then you will not need to worry about taxes. That’s because they are responsible for self-employment taxes which includes medicare taxes, social security taxes, etc.
When you are a business owner, there are a lot of parts that you will need to manage. One important piece of your business is your workforce. Many people don’t realize that there is more than one type of worker! The type of worker you have will impact more than you think, especially when it comes to how your company handles taxes.
The two main types of workers are a W2 employee and a 1099 worker. While a W2 employee is the standard type of worker that most people think of, you may benefit from considering a 1099 employee. There are a lot of benefits that come along with a 1099 employee like:
- Tax Benefits
- Fewer Business Expenses
- Less Legal Risk
Determining the qualifications of a 1099 employee, like an independent contractor, can be a bit tricky. There are three main factors that you want to consider which includes:
- Behavioral Control
- Financial Control
- Relationship with the Worker
These factors can help you determine whether or not the employee would be a W2 or a 1099. However, the best way to determine is by getting help from a professional like a tax advisor!