As a business owner, one of the most important decisions you make is who you hire.
Whether you’re just starting, or are a seasoned entrepreneur, there inevitably comes a time when you will need to hire additional staff to help keep up with business growth.
It doesn’t matter if you’re a small business that operates a restaurant locally, or an up-and-coming tech startup, understanding the options you have when staffing can make a huge difference in your company’s culture, finances, and productivity.
When looking to grow your staff, there are two main types of workers to consider: a W2 employee and a 1099 independent contractor.
Both the W2 employee and 1099 independent contractor each have unique benefits as well as specific disadvantages as well.
A well-run organization understands where to best leverage a W2 employee and when it makes business sense to invest in a 1099 contractor.
For starters, one of the main benefits of hiring a 1099 contractor is that you generally assume a lower legal risk when using the services of a 1099 worker.
Additionally, you are not responsible for paying a 1099 contractor any additional employment benefits that you are normally obligated to pay to a W2 employee.
In this 1099 vs. W2 guide, we’ll take an in-depth look at the pros and cons of each type of worker as well as specific examples of each.
We’ll also highlight the importance of classifying your staff correctly for tax time and examine why a hybrid approach of 1099 and W2 employees can often make the most sense for your business.
W2 Employees and 1099 Independent Contractors: What’s The Difference?
From a legal perspective, the main difference between an independent contractor and a W2 employee comes down to the type of form each receives for tax purposes.
W2 employees are generally afforded more rights and benefits because they are by law recognized as employees of the company, whereas an independent contractor is an individual who provides a service for a company but is not considered an employee.
1099 workers typically are cheaper to hire as they are not entitled to the health benefits that W2 employees receive when joining a company full time.
Let’s take a look at the specifics of each type of worker.
What Exactly Is a W2 Employee?
When you think of someone who has a 9-5 job at a company, you are thinking of a W2 employee.
They are the most common type of workers in the United States today. A W2 employee is an individual who works for a company in exchange for a salary and other benefits.
Workers that classify as W2 employees are expected to work certain hours and perform specific duties on a routine and consistent basis.
In this work arrangement, a business is expected to provide the training, tools, and resources necessary for the worker to perform his or her job to a reasonable standard.
Additionally, if you hire a W2 employee with the expectation that they will work from 9-5, you are within your right to ask that they work at those times.
However, if you were to hire an independent contractor, you generally do not have control over the hours they work.
Unlike when hiring independent contractors, for W2 employees, businesses are also obligated by law to withhold Medicare and Social Security taxes for W2 employees.
Employees under the W2 classification are also entitled to various retirement benefits and are often compensated for business expenses, such as air travel or filling up the gas tank on a company drive. Independent contractors are generally not reimbursed for business expenses unless otherwise stated in the contract.
By law, a business ensures W2 employees are paid at least minimum wage based on the state and federal laws at the time of the hiring.
As an employee of a business, the individual can be let go due to poor performance or a variety of other reasons, but reasons not based on discrimination.
Because of the costs of training and benefits, W2 employees are often considerably more expensive than 1099 independent contractors.
According to a highly cited and researched study done by MIT, “The costs to this point (basic salary, employment taxes, and benefits) are typically in the 1.25 to 1.4 times base salary range, e.g., the cost range for a $50,000/year employee might $62,500 to $70,000.”
A business will generally only invest in an employee if they believe there is a long term mutually beneficial working relationship. When hiring staff, the W2 status is often the default classification.
Examples of W2 Employees
● A fast-food worker who works 40 hours a week.
● A finance manager who is told she must be at the office from 9-5 Monday through Friday.
● A nurse who works weekend shifts and some weekdays.
Now that we’ve covered W2 employees, let’s take a look at 1099 workers.
What Exactly Is a 1099 Independent Contractor?
A 1099 worker is a classification used to describe a worker who provides a specific service based on a mutually agreed upon contact. When you think of the term freelancer, you’re thinking of a 1099 worker.
Independent contractors often provide a unique and highly specialized service that a business may not necessarily need regularly. For example, you might hire a 1099 worker for marketing consultation to grow your coworking space for an hour each month.
Independent contractors can determine how and when they work, as long as the defined services are rendered and expectations are reasonably met.
A business who hires 1099 workers and utilizes their services is not required to pay payroll taxes for them, which is one of the most significant reasons businesses often leverage the help of independent workers.
For example, if a 1099 web designer charges you a flat fee of $3000 for redesigning your website, as a business you would not need to withhold any amount of that payment for tax purposes. Likewise, you would not need to pay the additional benefits that you otherwise would have to for a W2 employee.
The independent contractor in question would be responsible for ensuring they are paying the required taxes on their income based on the services they provided. In addition to being responsible for their taxes, 1099 workers do not receive any benefits, such as paid time off or health insurance.
According to a recent report on independent contractors, “employers can save up to 30 percent by hiring an independent contractor because they avoid paying payroll taxes, unemployment insurance, workers’ compensation, and disability, as well as benefits that include pensions, sick days, health insurance and vacation time.”
Examples of 1099 Workers:
● Drivers of car share services such as Lyft and Uber;
● An independent digital marketing consultant;
● A web designer who works while traveling the world; and
● A copywriter who helps businesses with their copy.
Now that we have defined the two types of workers you can hire, let’s take a look at the benefits of each.
Benefits of W2 Employees
Perhaps the most significant benefit of investing in a W2 employee is that they provide stability for you and your business. In most cases, the expectation is that the working arrangement will last at least one year if not longer.
Not having to look for new people to hire continually can save you a lot of time and frustration. Additionally, an employee is likely to have more company buy-in than a contractor who is working with other clients.
In many cases, employees will remain loyal to your business as long as they feel they are compensated fairly and challenged professionally.
More Efficient Use of Time
Employees compared to contractors also save you a significant amount of time. While employees do require training when starting their job, you don’t need to continue to train them once they have learned the basics of their specific role.
However, with each new contractor you hire, you have to spend time getting them up to speed on your business objectives.
Internal Employee Advancement
Because the hiring process is often a significant financial investment, having employees who can advance throughout the organization can save your business money over time.
Instead of having to interview a dozen candidates for an executive role within your company, you can ideally promote an employee who has shown promise over the years.
Not only can internal advancement save you money when hiring, but you also reduce your risk of hiring an individual who is ultimately not the right fit.
Benefits of 1099 Independent Contractors
For a business on a tight budget, 1099 workers can often be a great option when looking to hire. 1099 workers do not qualify for overtime, minimum wage, or any of the additional benefits your company employees receive, which can massively reduce your staffing costs.
Because indecent contractors are also responsible for their tax obligations, your finance and HR department do not need to withhold any taxes for them.
In addition to being cheaper to hire, independent contractors also provide your business with much more payroll flexibility.
Investing in a traditional W2 employee is a serious financial commitment, whereas hiring a contractor can be put on hold if needed, depending on whether your businesses finances are in a healthy state.
If a contractor you hire doesn’t work out, it’s better than having to find a new full-time employee.
Find Solutions To Your Problems Quickly
Another excellent benefit of hiring a 1099 contractor is that you can often find solutions to your business problems quickly.
Do you want a consultant to help you improve your product offerings? A few hours will do the trick.
Or do you need your website redesigned? A freelance web designer can help you do that at a reasonable cost.
1099 contractors are often really good at their area of expertise, which can save you a ton of time and money.
How To Correctly Classify W2 versus 1099
Whether you choose to hire a W2 employee or 1099 worker, it’s crucial that you classify your staff correctly. Improperly classifying a worker is one of the quickest ways to get on the wrong side of the law.
According to the IRS, “Classifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes. Certain employers that can provide a reasonable basis for not treating a worker as an employee may have the opportunity to avoid paying employment taxes.”
Up until recently, the IRS used a 20-factor test to help determine whether an individual may classify as a W2 employee or 1099 worker.
It’s important to note that the IRS does not currently use a checklist to determine the classification but instead looks at each situation on a case-by-case basis.
That said, there are three distinct categories which the IRS uses to determine whether or not a worker is an employee or independent contractor.
As stated by the IRS website:
* Behavioral control (whether there’s a right to direct or control how the worker does the work);
* Financial control (whether there’s a right to direct or control the business part of the work); and
* Relationship of the parties (how the business and worker perceive the relationship).
If you control when an individual must arrive at work, that individual is likely to be considered an employee.
If you pay for a one-off service in which the scope is clearly defined via contract, that the individual is likely to be considered a 1099 worker.
When it comes to wrongly classifying a worker, ignorance is not an excuse. It’s up to you as a leader of your business to understand the ramifications of how each of your workers should be classified.
Investing the time to understand the differences between a W2 employee and 1099 worker can save you a lot of time, money, and hassle.
If you’re ever in any doubt as to how to classify a worker correctly, we highly recommend you seek the legal advice of a tax professional to ensure you make the right decision based on your specific organizational needs.
Which Should You Choose: a 1099 Independent Contractor or a W2 Employee?
Deciding whether to hire 1099 vs. W2 workers is a challenge all business owners face. Each type of worker has its benefits, and each type of worker comes with a unique set of challenges and disadvantages well.
Ultimately, the most successful organizations today rely on a hybrid approach to their staffing. When possible, investing long term in W2 employees can pay serious dividends down the line.
However, hiring specialized contracted help can be a cost-effective and strategic investment.
Contractors can be an effective way to solve your biggest business challenges quickly, while investing in your employees now provides your company with much-needed stability.
Understanding your goals as an organization and your current financial picture will help you decide which type of worker you hire next. Depending on where you are in your stage of business, it might be the right call to hire W2 employees, or it may be more effective to rely heavily on 1099 workers.
Both W2 and 1099 workers have their place and should be carefully considered as you grow and scale your business.