1099s vs. W2 Employees. What’s the difference?

If you have landed here, you are probably considering reducing the number of full-time employees (W2) and hiring self-employed independent contractors (1099) to perform specific jobs. There are significant differences in how these two types of workers are classified with the Internal Revenue Service (IRS). Knowing these differences is crucial if you want to avoid hefty fines, tax penalties, and even a lawsuit against your North Carolina business.

Related Blog: 8 Common Business Tax Deductions

Who is a W2 employee?

A W2 employee is someone who you recruit and add to your payroll — your typical, salaried employee. The litmus test used by the IRS to determine whether someone is a W2 employee is when the business controls what work is done and how it is done. The company manages the specific details of how the job is done even if the employee enjoys considerable autonomy in doing their job.

According to IRS regulations for W2 employees, you must withhold income taxes from the employee’s paycheck and provide them with a minimum wage and other benefits such as health insurance, overtime pay, unemployment insurance, and workers’ compensation insurance. You must also provide W2 statements to employees at the end of each year and report their earnings to the IRS.

Who is a 1099 employee?

1099 contractors are independent contractors hired to perform specific tasks outlined in a written agreement. While businesses can control or direct the results of their work, they have no control over what is done to deliver the results or how the job is done.

You are not required to withhold taxes from the contractor’s check or pay payroll taxes in most cases, though you must provide them with a Form 1099-MISC, which they will use to report their earnings. According to 1099 employment rules, an independent contractor is not entitled to minimum wage, health insurance, paid time off, and overtime. They are not also covered by workers’ compensation or unemployment benefits.

Understanding the Difference

With a W2 employee, you make all the decisions. You decide how they work, when they work, what they can (and cannot) do, what level of performance is acceptable, and how much they will be paid. A W2 employee may work in your office, using a desk and computer provided by you, and be assigned to a fixed shift. They work for your business on an ongoing basis, and you have complete control over how they carry out their responsibilities.

1099 workers, on the other hand, make their own decisions. They have complete control over how the work is done and how much they are paid. They are responsible for outcomes rather than processes. A plumber or electrician you hire to deal with an issue at your business is an example of a 1099 worker. You tell them what you want done but rely on their experience and expertise to get the work done right.

As an employer, you bear the responsibility of deciding how to classify workers. Unless they meet the stringent standards for being an independent contractor, they are presumed to be employees under the law.

Reasons to hire W2 employees

• W2 employees get the job done in the manner that you specify.
• W2 employees are more consistent in their job and more loyal to your business. Because 1099 workers are free to work with other clients, you are not their exclusive priority.
• You can reassign W2 employees to other roles and responsibilities as needed by your business. 1099 workers are hired to perform specific tasks.

Reasons to hire 1099 workers

• You can engage 1099 workers on a project-by-project basis. This allows you to be more flexible as your business priorities change.
• 1099 workers may be able to bring specialized expertise to the table that your employees do not have. If you have a project that requires particular design or technical skills, you will almost certainly be able to find an independent contractor for the job.
• When you engage 1099 workers, you may be able to reduce your business expenses because you will not be required to provide benefits or overtime.
• There is also less paperwork involved because you are not required to withhold taxes.

Common-Law Rules

The IRS will consider the degree of control and independence in the following categories when deciding whether someone is a W2 employee or 1099 employee:

• Behavioral: Are you in charge of or have any authority over what the employee does and how they perform their responsibilities?
• Financial: Are you in charge of the financial parts of the employee’s job? This could include how they are compensated, whether job-related expenses are covered, and who provides the necessary tools to get the job done.
• Relationship: Is the work done a “critical part” of your business? Is this a long-term relationship? Are there any formal contracts or benefits associated with being an employee, such as health insurance, retirement contributions, and flexible spending accounts?

The level of control a business has over its workers is what the employee classification process ultimately comes down to. If you control the majority of a worker’s job, they are most certainly a W2 employee. If they have a high level of autonomy, they are probably a 1099 worker.

If you are still unsure whether someone is a W2 employee or a 1099 worker, you can seek clarification from the IRS. There is a form for it (Form SS-8), but it can take up to six months to get a determination.

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