July 13, 2023 | Last Updated on: April 25, 2024
When hiring for your company, you’ll find that those you hire fall into two potential categories: 1099 or W-2 Employees. As a small business owner, understanding the different types of hires will go a long way towards avoiding an unfriendly visit from the IRS. So what exactly is the difference between 1099 and W-2 Employees? It’s simple!
1099 workers complete specific tasks for you. On the other hand, W-2 Employees receives a regular wage or salary for their work. So the big difference is that 1099 workers get paid task-to-task, while your business pays W-2 Employees a wage regardless of the number of tasks they complete.
It’s that simple, right? Well, not so much. There’s much more to consider, such as the different types of W-2 workers, deciding which type works best for your specific needs, and tax rates.
In this article we will walk you through everything you need to know about 1099 workers and W-2 Employees, from the necessary tax forms, to the different sub-types of workers, and plenty more financial management tips.
We touched upon this in the introduction, but the IRS has a specific process for determining whether the type of relationship is a 1099 or a W-2. The IRS breaks it down into a few sections:
The most flexible of the three, a lot goes into determining the relationship between the worker and the employer. Does the worker get employee benefits such as health insurance? Does the worker get paid time off? Is the relationship between the worker and the employer considered permanent or on a case-by-case basis? The bottom line is that it’s for you to determine whether or not the worker fits into the realm of a 1099 or W-2 worker.
Does the employer control the worker’s work and how they complete their work?
Does the employer control the business aspects of the worker’s job, such as who pays for supplies, whether or not business expenses are reimbursed, and more.
Now that you understand the differences between the two types of workers, let’s walk you through them on individual levels.
1099 workers are self-employed and receive payment based on the individual tasks they perform. So rather than having said person receiving salary+benefits regardless of how much work they do, 1099 workers receive payment only when they complete work.
The most common form of 1099 workers is independent contractors. The IRS defines independent contractors as “if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.” This is a sophisticated way of saying that whether or not you’re an independent contractor is dependent on how you get paid.
This type of working relationship is popular among small businesses looking to avoid overspending. In fact, more small businesses are hiring independent contractors than ever, working with the self-employed rather than hiring employees instead.
Independent contractors typically work on specific projects like freelancers do. Freelancers, or self-employed workers, like independent contractors, set their own rates and accept assignments they want to work on. The difference, however, is that independent contractors typically work on projects for longer than the short-term projects freelancers work on. Next, you have two opposites of the pay spectrum in gig workers, who typically work individual jobs such as singular events, and consultants, who are typically paid well to provide expert knowledge on specific topics.
Those are the different types of 1099 workers that you will likely consider working with as you’re hiring. On the flip side, you may consider hiring salaried employees. That’s where W-2 workers come into play.
Related: The Definitive Guide to Small Business Tax Rates
After reading up on 1099 workers, you may be wondering why businesses hire W-2 employees at all. With 1099 employees you don’t have to worry about paying employees beyond the tasks they complete. Additionally, you don’t need to worry about benefits. But there are perks to hiring W-2 employees as well.
Hiring a W-2 employee means that you have more control over when, how, and what work the employees complete. That level of control can be essential for small businesses, as they can pay much closer attention to individual employees compared to larger businesses.
When considering hiring a W-2 employee, it’s important to note that they do not need to be full-time employees. Despite the common misconception, the reality is part-time employees can be W-2 employees as well. For example, W-2 employees could be anyone from a salaried personal banker to an hourly teller.
As businesses consider whether they want to hire 1099 or W-2 workers, they must consider the tax ramifications as well.
We’ve discussed why many small businesses prefer 1099 workers over W-2, but we haven’t yet covered one of the most important reasons why. Taxes!
Businesses can save around 30% by not needing to pay taxes that they would typically have to pay for their W-2 workers. Let’s break down how the taxes work.
A 1099 worker refers to the type of tax form the worker is expected to complete. 1099 workers are responsible for their own tax withholdings. The taxes paid by 1099 workers are often referred to as self-employment taxes. There’s plenty you need to know in order to be compliant on the business side of things.
First, note that a 1099 form is a series of documents used by businesses to report payments made to an independent contractor during the past year. You must use form 1099-MISC to report payments made to 1099 workers. It’s entirely your responsibility to send a 1099-MISC form to 1099 workers who made $600 or more in a calendar year. Next, you must ensure you file the 1099-MISC as well. You can receive access to hard-copy 1099-MISC forms via the IRS here.
Once you’ve filled all of the 1099-MISC forms, there’s more to do. Form 1096 provides a summary of all the 1099-MISC forms you filled. This form must also be sent to the IRS, unless you filled out your 1099-MISC forms electronically.
If you have any further questions or need access to additional forms, the best bet is to visit the IRS website.
Now that you understand how 1099 workers are taxed, it’s time to dive into W-2 taxes. W-2 employees receive W-2 forms. W-2 forms inform employees how much they’ve earned from their employers in the last year and how much withholding tax they’ve paid on those earnings. An employee’s paychecks will see the employee’s wages with the taxes, such as state income taxes and federal taxes, taken out. Employees should receive a W-2 from every employer who paid them at least $600 during the year. Their W-2 will determine whether they receive a tax return or have to send a check come tax season.
Once an employee receives their W-2 form, it’s important for them to look over it carefully to make sure they understand what’s taxable and what’s not. For example, an employee’s W-2 tax form may show their retirement plans contributions are not taxable. This is important information to know.
There are many boxes that must be considered on a W-2 tax form. Among these are how much the employee was paid, how much federal income tax was withheld, how much pay was subject to Social Security tax, how much was subject to Medicare tax, how much tip income was reported to the employer, and more.
Now that you know the difference between the two types of workers, you may be wondering what happens if you get the worker classification wrong. You have a great degree of control over how your workers are classified, so misclassification can be a daunting concept. Don’t worry, we’ve got you covered.
Say your business needs were met by someone you thought was a 1099 worker but it turns out they were actually a W-2 employee. Whether they make minimum wage or more than anyone in your company, a misclassified employee can be a scary thought when you know you’re dealing with the IRS. So what happens if you misclassify someone who works for you?
Part of the reason we’ve gone into great detail about the differences between 1099 and W-2 employees is that the IRS takes misclassifications very seriously.
As recently as 2017, at least 10-20% of employers misclassify at least one employee. To avoid joining that group make sure to follow our above guidelines for who fits into the classification of a 1099 worker and who fits into the classification of a W-2 worker. However, if you run into any troubles, there could be steep penalties.
Keep in mind that the IRS considers whether or not the mistakes were made intentionally. If it’s found that you misclassified employees intentionally, you will be subject to stricter penalties. Regardless, penalties could include:
As we’ve said, the IRS takes this very seriously, so it’s imperative that you classify your employees correctly.
Now you know the differences between the two types of workers, the taxes faced, and the punishments if you misclassify. The last step is to determine which type of worker is better for you.
Small businesses often opt for 1099 workers. The reasoning is that despite the lesser control the small businesses have over the day-to-day operation of the workers, there is a cost to having that level of control.
Consider this: if you hire someone as a 1099 worker, you don’t need to worry about employee-type benefits. A non-employee such as an independent contractor doesn’t receive such benefits, nor do they receive payment beyond the project-to-project basis you work out with them.
There is definitely a benefit to keeping the costs down for your company. As a small business there are many challenges you’re going to face, and increasing costs for employees is not another challenge you need.
However, if you have the money to afford a W-2 worker, you do get the extra control and the ability to work on a more consistent basis with the worker. It truly comes down to your individual situation and what works best for you.
So there you have it. With the understanding of the differences between 1099 workers and W-2 workers, the knowledge of the tax differences, the potential punishments for misclassification, and why many small businesses opt for 1099 over W-2 workers, you have all the information you need to make informed decisions moving forward.
Keep in mind that not all workers will want to provide the flexibility you prefer as well. Sometimes the perfect worker will insist on being a 1099 worker when you’re looking for a W-2 or vice versa. You can always move them between the two different types over time as long as you continue to follow the necessary steps to do so.
As long as you stay on top of things you shouldn’t run into any issues, leaving your workers and your business in great shape.
