You’re ready for some help around your business. Should you hire a W-2 employee or a 1099 contractor? The choice might not be yours. There are key differences between a W-2 employee vs. a 1099 contractor that you must understand to stay legally compliant.
Learn more about W-2 employees and 1099 contractors, the difference between them, and which is better for your business needs.
W-2 employee meaning
A W-2 employee is someone on your payroll who has a long-term relationship with your business. You can hire full-time or part-time employees. Employers control employees’ work schedules and how they do their jobs.
Benefits: Employees receive workplace benefits such as health insurance, unemployment insurance, workers’ compensation, and 401(k) plans.
Taxes: Employers are responsible for withholding taxes from employee wages. Employers also contribute Social Security and Medicare taxes for each employee.
Labor Laws: Employees are protected under labor laws, including minimum wage and overtime regulations.
Reporting: Report employee wage and tax information on Form W-2, Wage and Tax Statement, after the end of the year.
1099 contractor meaning
A 1099 contractor is someone you hire to perform a specific job for your business. Contractors are not on your staff and therefore not on payroll. They are self-employed and have a more short-term relationship with your business.
Benefits: Contractors do not receive workplace benefits because they are not members of your staff.
Taxes: Do not pay or withhold taxes from contractors’ pay. Contractors are responsible for paying self-employment taxes. However, you must withhold a flat tax of 24% from contractor payments if the worker is subject to backup withholding.
Labor Laws: Independent contractors are not employees at your business. They are not subject to labor laws.
Reporting: Report contractor pay on Form 1099-NEC, Nonemployee Compensation, if you pay an independent contractor $600 or more during the year.
1099 contractor vs. W-2 employee: What’s the difference?
There are several differences between a 1099 contractor and a W-2 employee. As a business owner, you must know these differences to avoid misclassifying workers.
Misclassifying an employee as a contractor can lead to significant penalties such as back wages and taxes, fines, interest, and jail time.
Why are the penalties so steep? Businesses have significantly more responsibilities for employees than they do contractors. Employers must withhold and contribute taxes on employee wages, provide unemployment and workers’ compensation insurance, and follow the Fair Labor Standards Act. Between benefits, taxes, and other employee perks, an employee can cost 32% more than a contractor.
Businesses don’t get to decide who is a 1099 contractor and who is a W-2 employee. The Department of Labor and IRS have rules you must follow to determine worker status.
Department of Labor worker classification guide
The Department of Labor’s Employee or Independent Contractor Classification Under the Fair Labor Standards Act Final Rule provides six guidelines. ‘
Use the following six factors to help you determine whether a worker is a 1099 contractor or W-2 employee:
- Opportunity for profit or loss depending on managerial skill
- Investments by the worker and the potential employer
- Degree of permanence of the work relationship
- Nature and degree of control
- Extent to which the work performed is an integral part of the potential employer’s business
- Skill and initiative
You must consider all six factors equally under the new DOL contractor rule 2024.
IRS worker classification guide
The IRS uses a three-part test known as “common law rules” to determine if a worker is a contractor or employee.
Use the following three IRS factors to help you determine worker status:
- Behavioral: Does the business control how the worker does their job?
- Financial: Does the employer control how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.?
- Type of relationship: Does the business offer employee benefits (e.g., vacation pay)? Is the work integral to the business? How long is the relationship between the worker and the company?
You can fill out Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, for help. The IRS will officially determine the worker’s status for federal tax purposes after reviewing the facts.
Hiring a W-2 employee vs. a 1099 contractor
So, should you hire a W-2 employee or 1099 contractor for your business?
Consider factors such as the nature of the work, the duration of the relationship, and your business’s needs.
Here are just a few considerations to make when deciding what type of worker you need:
| Hire a W-2 Employee If: | Hire a 1099 Contractor If: |
|---|---|
| You want someone to work indefinitely for your business. | You need help with a specific project that is definite in duration. |
| You want to control how the worker does their job. | The worker controls their schedule, work, and ability to work for others. |
| The work is an integral part of your business. | The work is not central to your business. |
| You plan to provide materials and equipment. | You need the worker to bring their supplies. |
Let’s say you run a T-shirt business. You need to hire a worker to redesign your storefront. You would likely hire a 1099 contractor. The contractor would bring the necessary supplies and equipment. The project is definite in duration (i.e., it ends when the redesign is complete). The contractor sets their schedule and takes on other projects for other businesses.
Consider consulting a lawyer or accountant to ensure you classify workers correctly.
How does the IRS determine if a person is an independent contractor or an employee?
Again, the IRS uses three rules to determine if a person is a contractor or employee. These rules look at the worker’s control and independence:
- Behavioral: Does the business control what the worker does?
- Financial: Does the business control how the worker is paid and provide reimbursements and tools?
- Type of relationship: What does the relationship between worker and business look like?
Do employers pay taxes on 1099 workers?
Employers do not pay taxes on 1099 workers. Taxation is one of the biggest reasons worker classification is so important.
1099 workers are responsible for paying self-employment tax, which is both the employer and employee portions of Social Security and Medicare taxes.
Some employers purposely misclassify employees as independent contractors to avoid paying taxes on their wages. Employers who incorrectly classify employees as independent contractors are subject to hefty penalties, including back taxes, interest, fines, and more.
Is a W-2 employee an independent contractor?
A W-2 employee is not an independent contractor. W-2 employee vs. 1099 contractor is an important decision business owners must make.
Again, W-2 employees are on a company’s staff, unlike contractors. Employees receive benefits, and the employer handles payroll taxes.
What qualifies as a W-2 employee?
A W-2 employee is a worker on your payroll. You control the work they do, determine how they’re paid, and have a long-term relationship. Typically, the work performed is integral to your business rather than a side project.
There are several rules employers must use to determine worker status. The Department of Labor and IRS set rules to reduce the risk of misclassifying employees as contractors.
Review the Department of Labor’s Employee or Independent Contractor Classification Under the Fair Labor Standards Act for more information on the six-factor test.
Review the IRS’s common law rules for more information on its three-factor test.
Can an employee have both W-2 and 1099?
Yes, an employee can receive both a W-2 and 1099. The worker might be your employee and do side projects as a contractor. Or, the worker might start as a 1099 contractor before you hire them as an employee.
Whatever the situation, you must create Form 1099-NEC if you pay the worker at least $600 for their work as a contractor. You also need to prepare Form W-2 for employees.
Let’s look at an example that the IRS provides. A custodian who works for a county public school is an employee and receives a Form W-2. He also owns a snow-plowing business on the side. He provides snow plowing services for the county on nights and weekends and receives a Form 1099-NEC for this work.
Ready to hire a W-2 employee or 1099 contractor?
Understanding the difference between W-2 employees and 1099 contractors is important for legal compliance.
A W-2 employee is a full-time or part-time worker who is on your staff and receives benefits. You must withhold taxes from their wages and contribute employer taxes. The employee is also subject to labor laws, such as overtime pay.
A 1099 contractor is a self-employed worker you hire to perform a specific job for your business. You do not offer benefits or handle taxes, and the worker is not protected under labor laws.
The Department of Labor and IRS provide rules to help businesses decide whether a worker is a W-2 employee or a 1099 contractor. Follow these rules closely to avoid misclassification and penalties. You can consult an accountant to help.
Paying your W-2 employees and 1099 contractors
Once you hire a W-2 employee or 1099 contractor, you need an efficient way to pay them.
Patriot’s online payroll lets you pay employees and contractors during the same payroll. You can pay employees or contractors with paper checks, direct deposit or a combination of both.
You can download Forms W-2 and 1099-NEC from the software to distribute to employees and contractors at no additional cost.
Sign up for a no-obligation demo to see how easy payroll is with Patriot Software!
This is not intended as legal advice; for more information, please click here.
