Comparison Between Form 1099 vs W2 Form for Employees
Maintaining a dedicated team of employees is harder than it looks. The most challenging aspect is to differentiate the employees at the time of tax season. Without a dedicated HR persona or payroll services, it is hard to handle employee relationships. With the monetary responsibilities, the cost of hiring new staff can consume 40%-80% of your budget!
So when it’s about the expense, businesses have to ask whether to hire 1099 vs W2 employees or not? There are major differences between the two. IRS classifies the 1099 employees in a separate league than that of the W2 employees.
For this very reason, it is recommended to learn the differences between W2 vs 1099 employees to avoid any mess during the tax season. This article is your guideline to highlight the differences.
What is a 1099 Worker?
Also known as independent workers, they offer services to the employer. The 1099 worker may work on the project once or it can become a recurring task. Mostly the 1099 workers serve multiple clients and offer their services as per expertise level.
The work engaged with the 1099 worker is for a limited time period. The contract highlights the work tenure length the contractor will be engaged for. Regardless of the length of the work, the 1099 workers decide the use of tools, and methods they will need to complete the task.
They can even choose to hire a team to work under them for task completion. So the risk of profit or loss lies on their shoulders.
The 1099 workers have to pay self-employment taxes (and so does the employer). You will still not need the payroll taxes. Also, the independent contractors are not eligible for the employee benefits like health insurance, etc.
What is a W2 Employee?
This is the standard employee who works as a permanent staff in the company. They do not own a business, but work for the company and are also eligible for employee benefits. They work according to the business schedule. A company is eligible to withhold W2 worker’s taxes for Social Security, Medicare taxes, and payroll taxes.
Employers are responsible to provide the necessary tools and supplies to W2 employees to complete the work.
Why should you Understand the Difference between W2 vs 1099?
There are a couple of reasons you need to know about differentiating 1099 vs W2 employees.
- To misclassify the worker in either category, can result in penalties by the IRS. or it can also result in a lawsuit against the business.
- The taxation will be based on employee classification. For instance, income taxes are withheld from W2 employee’s pay but not from 1099 workers.
- It also helps to determine the level of control the employer has over the task being done by the worker.
For small businesses, the classification can save them loads of money on taxes but sometimes the differences are murky. Relax! You are not alone in this. Now take a closer look at how to determine the differences between 1099 vs W2 employees.
How to Determine the Difference between 1099 vs W2 Employees?
We just classified the employees under two major categories. Differentiating between the employees allows you to maintain and plan according to your budget IRS is strict about classifying the workers in the right categories.
To be fair, it’s easy to hire a 1099 worker instead of a W2 employee. IRS has prescribed three categories to highlight the differences;
- Behavioral – Does the business control the nature of work being done?
- Financial – Covers the economical aspect of the job and payment method
- Relationship Type – Does the worker has employee benefits or not? What is the length of the contract?
We have already discussed this in our previous article about the independent contractor guide.
So if the company controls most of the work, then it’s a W2 employee but if the worker can make an independent choice then it’s a 1099 employee.
The Tax Differences between W2 vs 1099
One of the major differences between 1099 vs W2 employees is the tax implications. This also includes payroll tax compliance.
For a W2 employee, you pay half of their FICA taxes but that’s not the case with a 1099 employee. The contractors pay their own taxes.
Hiring a 1099 worker is cheaper than a W2 employee. Even if the contractor receives $100k it is less costly as compared to what is paid to the W2 employee.
The employer also has to pay half of the W2 employee’s Social Security Tax (as mentioned earlier). So if the employee receives the $100k it is equivalent to the contractor being paid $107,650 with the difference of 7.65% of Social Security Tax.
Take another example, a 1099 worker is paid $600 or more. You will need to provide them Form 1099-NEC. It should be submitted by January 31. A copy is also sent to the IRS. In case the independent contractor hires a team of their own, they are responsible for reporting the paperwork on their behalf as well.
IRS provides helpful information about depositing and reporting employment taxes for W2 employees. Since the employer withholds their taxes, you must differentiate between 1099 vs W2 employees.
Benefits and Disadvantages of 1099 Employees vs W2 Employees
Whether you choose to hire 1099 workers or W2 employees each helps to fulfill the business objectives, one way or another. So it’s best to learn about the pros and cons of 1099 vs W2 employees.
Pros of 1099 Workers
The 1099 workers work according to their specialized skills and expertise. They are well trained in their field and bring forth the experience for successful task completion.
- Shorter Contracts
Usually, independent workers are hired for short-term projects. It helps companies to avoid any high rise pay to the worker. On the completion of the project, the independent contractor moves on.
No withholding taxes make 1099 employees affordable instead of W2 employees. No added benefit is required either. You just pay the contractor at the task completion.
Cons of 1099 Workers
- Less or Zero Control
The independent contractors are free to complete the task as they see fit. So they do provide the outline about their pay rate, payment terms, and scope of expertise.
- No Protection against Compensation
No health insurance benefits are given to 1099 employees. In case the worker gets injured onsite, they will hold the company accountable for it.
- Legal Considerations
If you fire an independent contractor, it is a breach of contract. So, it’s best to have the contract with 1099 workers reviewed by the legal professional to avoid any legal problems.
Pros of W2 Employees
- More Control
Employers provide the work schedule and have better control over what’s going on and how a business process will be handled. If need be the employer can help in certain ways.
- Employee Longevity
An employee is less likely to switch a job. They work on a long-term basis with the company. Their longer tenure at the company allows them to have a better understanding of the business. So they can be more beneficial for the company.
Employees that are retained show more commitment to the business out of loyalty as compared to the independent contractor. A company’s thriving culture, work ethics, etc can become the reason for loyalty.
Cons of W2 Employees
- More Time and Effort
You need to train W2 employees at the time of hiring. Training employees take more time and effort that can be a loss in terms of productivity.
The company has to supply resources to the W2 employees to do the job. It includes training, tools, and other materials. Business has to bear resource expenses as well.
Employees can cost you a lot more than 1099 workers. You have to pay their FICCA taxes and other health insurance benefits. It increases the cost of hiring a W2 employee.
Which is Better to be: 1099 Employee or W2?
There is no hard and fast rule for hiring. For small businesses hiring 1099 workers is a smart choice. Or if you want someone to work on a short-term project then again independent workers are a better choice.
To cover your bookkeeping for a few hours, a part-time accountant is a better option. Or you can even outsource the accounting and bookkeeping services.
My Count Solutions is a safer choice for many small businesses who are looking to hire a remote accounting and bookkeeping service. If you want a law expert on your hands, none can do better than professionals at My Count Solutions.