Management of human resources is one of the most challenging aspects of running any small business. Without the presence of a dedicated HR (Human Resource) team, it becomes difficult to handle processes like employee onboarding, employee relationships, payroll administration, and other core HR-specific tasks. In addition to the time and cost of these responsibilities, you also need to account for the overall monetary costs associated with staffing. Staffing costs –depending on your industry, can consume around 40 to 80 percent of the total budget of the company.
Due to this expense, most small business owners are confused about hiring the W2 or 1099 employee for specific positions. There are significant differences between the two types of employees. Classification of the two with the IRS is crucial. Therefore, businesses can consider seeking reliable help from professional employment attorneys while classifying workers.
Apart from legal issues, there are specific merits as well as demerits of hiring independent contractors or employees. It is important to make the right choice for any business.
W2 Employee vs. 1099 Worker –What is the Difference?
Both employee categories are named after the subsequent tax forms. Organizations offer a Form-1099 MISC to the respective independent contractors who work with the company. There is also the provision of the W2 on behalf of the organization’s employees.
While both employees and independent contractors deliver valuable services to any company, there are still major differences between the two. Understanding the differences is crucial. If an employee ends up being misclassified in the form of an independent contractor, the company could be subject to legal fees and expensive fines. Moreover, when W2 employees are misclassified in the form of independent contractors, they could also sue your business for advantages they had been denied –including overtime pay, health insurance, and the minimum wage.
What is a 1099 Worker?
A 1099 worker is also known as an independent contractor. The individual is primarily concerned with delivering specialized services as defined by the written contract. There are some 1099 workers working only on a single project at a time. However, there are also contractors who serve multiple clients and provide services within their expertise. Independent contractors –including consultants and freelancers, are self-employed. Therefore, they are business owners themselves.
In most cases, businesses hire W2 employees with the purpose of working with them for an unspecified period of time. On the other hand, businesses indulge with independent contractors for a specified period of time as per the conditions in the contract. However, the engagement could be renewed several times for as long as the business owner and the independent contractor will find it mutually beneficial.
Regardless of the duration of their contract, independent contractors define for themselves where and how they will work and what methods and tools they will use for completing the work. 1099 workers can also think of hiring other workers to get access to the product or service that you asked for. As such, independent contractors are able to assume the overall risk of their own losses or profits while executing the job.
What is a W2 Employee?
A W2 employee is a typical, salaried employee. In comparison to independent contractors, W2 employees are not their own business owners. They work for an organization, become a part of the employee benefits programs, and do work as per the schedule and needs of the business enterprise. Unless there is a strong reason to categorize the worker as an independent contractor, the classification is W2 employee by default.
As per the law, employees are provided at least a minimum wage (as specified by both state and federal laws) for the duration they work on an ongoing and regular basis. Companies can withhold the Medicare and Social Security taxes of the W2 employees while paying employers payroll taxes. Mostly, an organization can allow an employee to opt for poor performance or any type of non-discriminatory reason. On the other hand, independent contractors work and receive payments as per the terms & conditions of the signed contract between the involved parties. They are also expected to pay their own taxes.
Employers offer access to all essential supplies and tools to the W2 employees, but independent contractors should provide their own tools. Additionally, employees are usually reimbursed for business-specific expenses incurred by them throughout the duration of their employment. This is not the case with independent contractors unless it has been specifically mentioned in the contract.
Benefits including flexible spending accounts, retirement contributions, and health insurance are made available for all qualifying employees in an organization. These benefits are not available for independent contractors working for any business.
Determination of W2 Employees vs. 1099 Workers
In most cases, the overall ease of hiring and cost are determining factors for selecting either a W2 employee or a 1099 worker. It is much easier to pay an independent contractor than administering payroll and handling other HR-related functions with employees.
However, all cost and time savings will be in vain if the Department of Labour or IRS audits the business and finds that employee misclassification occurred. As per the IRS, there are three core categories for determining when individuals are independent contractors or employees.
- Type of Relationship: Are employees provided with employee benefits? What are the terms and duration of the relationship, as specified in the employment agreement, contract, or any other document?
- Financial: Who is responsible for controlling different aspects of the job of the workers? What is the payment method?
- Behavioural: Is the business capable of controlling how, what, when, and where the workers are carrying out their jobs?
If the organization controls most of the work of the individual, then the individual is a W2 employee. If the individual has a decent level of independence, then the worker is an independent contractor. To analyse the same, businesses can file Form SS-8 with the IRS and the IRS will determine how businesses should classify the respective workers.