With positions and scopes of work growing increasingly complex, more and more companies opt to hire different types of workers. Deciding whether to hire full-time W2 employees or 1099 independent contractors depends on several factors, including taxes, compensation, and benefits. This article will outline all of the relevant factors so you can understand them better and make an informed hiring decision.
Difference between 1099 independent contractors vs. W2 employee
We deal with two types of workers in this article: the independent contractor (1099 worker) and the employee (W2 employee).
Simply put, the W2 employee is a standard employee - the employer pays them a salary or wage, withholds their income tax, pays their payroll taxes, health insurance, and provides other employee benefits. On the other hand, an independent contractor is an individual or entity who works for a company on a per-project basis for a set fee. Independent contractors are not entitled to employee benefits - being self-employed, they cover all of those expenses and pay taxes for themselves.
There are benefits and challenges for each of the two worker types, and different legal obligations and tax forms. Continue reading for a more detailed breakdown.
What is a 1099 worker?
A 1099 worker is often known as an independent contractor or a freelancer. These are essentially self-employed workers, and you are their client. The name 1099 worker is derived from the 1099 tax forms used for reporting their income. In most industries, independent contractors are usually hired for specific projects and limited, short time. However, in the modern (and global) work environments, independent contractors are often hired for more extended periods for all those services that are not the core of your business.
The most important aspect of hiring 1099 workers is taxes - independent contractors pay their own taxes, as well as other benefits. You are essentially paying them a lump sum for their services, while the business expenses such as equipment and licenses fall under their responsibility.
Contractors are basically small business owners who work for multiple clients and don't enjoy employee-type benefits.
Pros of hiring 1099 independent contractors
Many companies can benefit significantly from hiring 1099 workers, especially in addition to their existing base of full-time employees. We've written extensively about the benefits of hiring independent contractors, but here are the most important ones:
- Supplementing your business needs
If your company needs certain services (such as design projects, programming, or machine maintenance), 1099 workers can provide you with great quality of work without the need to hire a dedicated full-time employee.
- Managing a fluctuating workload
Since independent contractors are usually hired per project, there is no need to worry about them not having anything to do once their tasks are over. 1099 workers are ideal for companies whose work has seasonal upticks or any other fluctuations during the year.
- Gaining access to a broader talent pool
When you hire independent contractors, you can choose from a global talent pool. Maybe the specialist you are looking for is located halfway across the world and offers incredible quality for a lower price. Unlike with employees, you can hire 1099 workers anywhere in the world without any legal barriers.
- Cutting costs
Full-time employees sign employment contracts that protect their rights and put specific responsibilities on their employers. On the other hand, independent contractors are not employees, and they bear the risks and benefits of their businesses themselves, which leaves their clients with a significant portion of savings on FICA taxes and employee benefits.
Cons of hiring 1099 independent contractors
Now that we laid out the pros let's see what the cons of hiring independent contractors are:
- The lack of control
One of the defining aspects of 1099 workers is their independence while performing work. As their client, you cannot control when or how long they work, their workspace and location, and their methods. The degree of control you have when working with 1099 workers is the result of the work, and whether it satisfies the criteria you agreed on. The bottom line is that 1099 workers are not an excellent choice for those with trust issues or micromanaging needs.
- Ownership challenges
A significant factor to pay attention to when forming contractor relationships is the ownership of the work and its final products. In some cases, if you haven't explicitly stated otherwise, the result of the work could belong to the independent contractor and not the hiring company. Make sure to include an ownership clause or copyright transfer clause into the contract you make with the 1099 worker.
- Misclassification risks
By far, the biggest issue with hiring contractors is the misclassification risks that come along with this form of a working relationship. In the US, the IRS pays close attention to employee misclassification and treats it as a severe offense. Read more about what misclassification is and how to prevent it.
Pay your team effortlessly with mass payments
Pay your global team in a one click, with mass payments. We support payroll in over 120 currencies with flexible payment methods.Learn more
What is a W2 employee?
A W2 employee, usually known as a full-time employee, is a person hired by your company under a standard employment contract. This contract usually offers a salary, employee benefits, tax withholding, and other perks and benefits. The name W2 worker comes from a tax form W-2, used to report employees' wages and taxable income.
Unlike independent contractors, W2 employees need to abide by company rules (such as code of conduct) and follow work hours, holiday schedules, tasks, and requirements for their respective positions.
Pros of hiring W2 employees
Even though most companies and recruiters are familiar with employment contracts and procedures, here are some benefits of hiring W2 employees:
- Control and oversight
W2 employees work under the guidance and oversight of their employers, which means they work at the employer's premises, follow procedures and protocols, and adhere to the company's work hours. In other words, the hiring company can control every aspect of how employees do their job, including methods and outcomes.
- Ownership clarity
All the work employees do for a company automatically belongs to the company, and there are no uncertainties, unlike when it comes to 1099 workers.
Employees, especially those who have full-time contracts, usually work exclusively for their employers. This exclusivity means they don't take other jobs and clients, focusing entirely on their full-time job.
Cons of hiring W2 employees
Similarly to 1099 workers, W2 employees come with their own set of challenges during hiring and employment:
- Costs for the employer
If you are an employer, your W2 workers are entitled to employee benefits, such as health insurance, retirement plans, etc. Depending on your location, these items can quickly add up and increase your total business expenses. Don't forget the legal and bureaucratic aspects of these contracts, and they can add up quickly too!
- Predicting the workload
Once you hire a W2 employee, you can't simply fire them because their workload has gotten smaller. Hiring employees means predicting their positions, roles, and workloads well and making sure they always have tasks to complete, which isn't always easy.
- Training and equipment
W2 employees work for your company exclusively, which means they use your equipment, as well as your work methods and strategies. Once you hire a W2 employee, you need to onboard them and provide training and equipment to get them started. Both of these require time and money, once again increasing the cost for the employer.
Employee classification: W2 employee or 1099 independent contractor?
The IRS offers guidance on some factors that help determine whether a worker is an independent contractor or a W2 employee. These factors are:
1. Behavioral control - Does the company control how the worker does their job and what they do to achieve the work results? If so, the worker is most likely considered a W2 employee. If the company only controls the result of the work, the worker is most likely an independent contractor.
2. Financial - Does the company reimburse expenses to the worker? Does the company influence the overall financial stability of the worker's business? Does the company provide tools and equipment for the worker? if the answer to these questions is no, the worker is most likely an independent contractor. If the answer is yes, the worker might be considered a W2 employee.
3. Type of relationship - Does the worker get typical employee benefits such as days off, retirement plan, and healthcare? Is the job a worker does for the payer a key aspect of the business? Is the relationship long term, or does it end once the job is done? If the benefits are covered by the employer and the relationship is ongoing, the worker is most likely a W2 employee. Otherwise, the person is considered to be an independent contractor.
There is a thin line between a W2 employee and a 1099 worker, but something that might help you determine the worker classification is the IRS 20 Factor test.
Can you be both a 1099 and a W2 employee?
Actually, yes, this is possible! The IRS gives an example on their website of a single person being both a W2 employee and an independent contractor with different written contracts. However, an IRS audit may happen if your company files both tax forms for the same person. The IRS may want to check whether you are doing everything according to the law and not misclassifying employees.
W2 vs. 1099: taxes, benefits, and rights
Let's cover some fundamental differences between employees and contractors. Deciding whether to hire a 1099 or W2 worker determines how your company and the worker will be taxed, as well a the IRS tax forms you need to file and collect. The key differences between W2 employees and 1099 contractors are:
The tax forms
Employers need to file the IRS W-2 Form (Wage and Tax Statement) for full-time employees, while for independent contractors, the company files IRS Form 1099-NEC, which is the form used to report non-employee income on the company's tax return at the end of a calendar year. Keep in mind Form 1099-MISC was used to report non-employee income until 2020 tax reporting.
Social security tax and employment taxes
Independent contractors pay their own taxes and benefits (including health insurance, income tax, and self-employment tax). On the other hand, employers cover Medicare taxes, social security taxes, and other benefits (FICA taxes) to W2 employees through tax withholding.
Independent contractors, as self-employed pay their own taxes (income taxes and self-employment taxes). Meanwhile, W2 workers have their income tax withheld by their employer.
Unemployment insurance and unemployment tax
Only W2 employees are covered by the unemployment tax payments by the employer. Independent contractors need to cover these benefits on their own.
Since payroll taxes do not cover them, independent contractors don't benefit from worker's compensation insurance. However, this also means that if they suffer from injuries while working for your company, they could sue you for compensation.
Paid time off, sick leave, parental leave, and other benefits
Companies only provide perks and benefits to their W2 employees. Since independent contractors are running their own small businesses, they schedule their own days off and the degree of benefits they want to have.
1099 vs. W2 employee: Which is better for employees
There is no straight answer to the question which is better for employees. W2 employees don't need to worry about income taxes and employee benefits, as it's all taken care of by the employer.
However, it may seem that independent contractors pay twice as much in Social Security and Medicare (FICA) taxes. 1099 contractors are also required to set up their own health insurance, purchase equipment, and establish a retirement plan. On the other hand, independent contractors can benefit from many tax deductions on their office space and supplies, travel, phone, and other costs. Take a look at the tax deductions for independent contractors.
So to determine which is better for you as an employee, you need to weigh in all the advantages and disadvantages and find the best solution.
Do 1099 contractors pay more taxes?
Although it might be compelling to be hired as an independent contractor, given the bigger sum you get paid, independent contractor taxes are higher. 1099 contractors need to pay income taxes, self-employment taxes, as well as cover their own social contributions (healthcare, insurance and other). However, as a 1099 contractor, you are most probably a business owner, which gives you the opportunity to apply tax deduction on many things. This will significantly reduce the taxes you owe, leveling the 1099 taxes to the W2 counterparts.
Read more about independent contractors taxes.
Switching employees from 1099 to W2
If you need to switch your 1099 contractor to a full-time employee, there are a few things you need to take care of:
- Determine the worker classification and inform the contractor about the transition
- Sign an employment contract and collect the necessary documents
- Put the employee on payroll and set up a payment schedule
- Collect W-4 and W2 forms to identify the necessary information for tax withholding
Read more about how to switch a contractor to an employee.