Many businesses will hopefully begin to rehire as they reorganize and recover from the epidemic. That’s fantastic news if you’re in that situation.
Table Of Contents−
- Why should you care about the distinction?
- The Real Cost of Hiring a New Employee
- W-2 Employees vs. Independent Contractors
- What Is a 1099 Employee?
- What Exactly Is a W2 Employee?
- How Should You Classify Your New Hires?
- Misclassification of independent contractors
- Employee and contractor advantages and disadvantages
- Hiring Process: 1099 vs. W-2
- Is it better to be a W-2 employee or a 1099 independent contractor?
- Managing the Costs of New Employees for Contractors and W-2s
- When and Why Should You Use a Staffing Agency?
- Is it possible for a worker to be both a 1099 and a W-2?
- How do you transition from employee to independent contractor or vice versa?
- How to calculate the hourly wage disparities between W-2 and 1099 employees
- How to Calculate W-2 and 1099 Employee Salary and Benefit Rates
- The tax implications of W-2s and 1099s
However, when you begin the recruiting process, you’ll want to examine whether employing employees or independent contractors makes more sense, and you’ll want to be sure you classify your recruits appropriately.
The latter is very crucial in the eyes of the IRS and, if done wrong, can result in significant fines. Your employees come into one of two categories:
W-2 employees or 1099 independent contractors.
Each form of hiring has advantages and disadvantages, and it’s important to conduct a cost analysis to decide which type is best for your business and the task you need to be done.
Use each type of recruit wisely—especially today, as you navigate a tough economy in the post-COVID-19 era—and you’ll accelerate your company’s growth while saving money.
Why should you care about the distinction?
For several reasons, it’s critical to understand the distinction between 1099 independent contractors and W-2 employees.
- Misclassifying an employee as an independent contractor might result in IRS fines or an employee misclassification lawsuit filed against your company.
- Employee classifications have an impact on how you and your employees are taxed. You must withhold income taxes and pay taxes on earnings paid to W-2 workers. Generally, you do not require to withhold or pay taxes on payments made to 1099 contractors.
- Employee categories govern your authority over a worker’s schedule, compensation, and other aspects of their employment. When, how, and where they work are all determined by independent contractors. Employees follow your regulations and work according to your timetable.
Every small company owner should know the distinctions between these classifications and when to recruit a W-2 vs. a 1099 employee. However, the distinctions are not always obvious. If you’re still unsure about the specifics, you’re not alone. Let’s take a deeper look at each category.
The Real Cost of Hiring a New Employee
During the coronavirus outbreak, several businesses laid off or furloughed employees. As the economy and small companies recover and things return to normal, company owners may need to increase their personnel.
However, before you can decide whether your next hire should be a 1099 contractor or a W-2 employee, you must first comprehend rehiring expenses.
You should factor in the time it takes to find, onboard, and train a new employee in addition to the hourly wage you want to pay. Consider the following expenses when calculating the true cost of hire:
- Posting job advertisements
- Time spent analyzing applications and conducting interviews
- Onboarding materials need a significant amount of time and resources.
- Overhead for maintaining staff, such as desks, tools, and so on, is necessary for role-specific training.
- The job’s hourly wage
- Benefits and other advantages provided
- The fees may vary depending on the sector and the general competence and wage level of the function you’re looking to fill. According to a study, businesses should double the cost of an employee’s salary by 1.2 to 1.4 times to account for overall hiring costs.
W-2 Employees vs. Independent Contractors
When you decide to recruit more people, you should know the benefits of the two types of hiring available to you. Both can help businesses fulfill their labor demands, but recognizing the difference is critical—misclassifying employees can result in penalties from your state and federal labor agencies.
What Is a 1099 Employee?
A 1099 worker, also known as an independent contractor, often delivers specified services that are outlined in a signed contract. While some 1099 employees only concentrate on one project at a time, many serve numerous clients by delivering a service within their area of expertise.
Because independent contractors, such as freelancers and consultants, are self-employed, they are also company owners.
Most of the time, businesses recruit W2 employees to keep them on for an indefinite period. Businesses, on the other hand, hire independent contractors for a certain amount of time-based on the terms of the contract.
However, the engagement may be extended as many times as both the 1099 employee and the business owner seem mutually advantageous.
Independent contractors determine how and where they work and the equipment and methods they employ to do the task you hired them for, regardless of the length of their contract.
1099 workers may also recruit their employees to assist them in delivering the product or service you hired them to supply. In other words, independent contractors risk their profit or loss when performing their duties.
Because your degree of control over independent contractors is limited, so is your level of financial and legal obligation. Because 1099 workers pay both employee and employer self-employment taxes, hiring an independent contractor eliminates the requirement for your company to pay payroll taxes.
Furthermore, because they are their company owners, 1099 employees are not eligible for the advantages you would provide to W2 employees, such as health insurance, paid time off, and overtime.
What Exactly Is a W2 Employee?
A W2 employee is what we often consider a conventional, paid employee. W2 employees, unlike independent contractors, do not own their businesses.
They work for your business, engage in employee benefit plans, and work around the demands and schedule of your organization. Unless there is a compelling cause to categorize a person as an independent contractor, the W2 employee classification is the default.
Employees are required by law to be paid at least the minimum wage (determined by both federal and state legislation) for the time they work on a regular and continuous basis. Companies deduct Social Security and Medicare taxes from their W2 employees and pay employer payroll taxes.
In most circumstances, a corporation can fire an employee for poor performance or any other legitimate, non-discriminatory cause. In contrast, an independent contractor works and is paid by the terms of a signed contract between the parties. They are also responsible for their taxes.
W2 personnel is provided with the essential tools and materials by their employers. Independent contractors are required to offer their own.
Furthermore, workers are often paid for business expenditures incurred during their job. This is usually not the case with independent contractors unless clearly stated in their contract.
All qualifying employees in a business are eligible for benefits, such as health insurance, retirement contributions, and flexible spending accounts. As previously stated, benefits are unavailable to independent contractors working for a company.
How Should You Classify Your New Hires?
According to the IRS, there is no single element that determines whether hiring is a contractor or a W-2 employee, but rather many to examine. The general nature of the connection and the employer’s influence over the hire’s job is most likely the best indicators.
Take into account the following:
- Will your organization control what the employee accomplishes and how and where the job is done?
- Will your organization control how much the worker gets paid and other financial components of the job, such as cost reimbursement?
- Is the employee eligible for benefits such as health insurance and sick leave?
- Is the individual employed full-time?
- If you answered yes to these questions, the recruit should most likely be a W-2 employee. Classifying a W-2 employee as an independent contractor may be extremely difficult; you could wind yourself paying the IRS back taxes and salaries and incurring fines from the Department of Labor or even facing litigation.
To be sure, the distinction between 1099 and W2 employees may get hazy—but the IRS gives some help on how to categorize your employees properly. When evaluating whether workers are employees or independent contractors, the IRS looks at three primary factors:
- Behavioral – Can your company manage what, where, how, and when the employee does their job?
- Financial – Who is in charge of the economic components of a worker’s job? What is the payment mechanism (e.g., a regular wage or a flat fee)?
- Relationship type – Do you supply this employee with employee benefits? What is the length and scope of this relationship, as defined by a contract, employment agreement, or other documentation?
The degree of control a company has over its employees is what the employee categorization procedure boils down to.
If the corporation controls most of the employee’s job, the worker is certainly a W2 employee. If the person has a high level of autonomy, they are most likely a 1099 independent contractor.
Even after considering the three elements listed above, are you unsure if a member of your team is a 1099 or a W2 employee?
Fill out Form SS-8 and return it to the IRS. In that instance, the IRS will judge how to categorize your workers on your behalf. The IRS can take up to six months to decide, but this is useful if you frequently employ for the same positions at your business.
Misclassification of independent contractors
It is critical to ensure that you accurately categorize your employees since misclassification can result in significant financial penalties (and no one wants unexpected charges!).
Employee misclassification occurs when employees are incorrectly categorized as independent contractors rather than employees.
When you misclassify employees, you fail to pay unemployment and other taxes on your employees when you should. And you aren’t providing workers’ compensation or unemployment insurance when you should be.
Suppose you are determined to have misclassified personnel as independent contractors. In that case, you will certainly be required to refund all the taxes and benefits you were not previously paying.
Typical monetary penalties include:
- Reimbursement for payments owed to an employee, such as overtime and minimum wage
- Back taxes and penalties for federal and state income taxes, as well as Social Security, Medicare, and unemployment benefits
- Payment of workers’ compensation payments for misclassified personnel
- Offering employee perks like health insurance and retirement schemes, among other things.
Employee and contractor advantages and disadvantages
Here’s a rundown of some of the advantages and disadvantages for both independent contractors and employees.
The Benefits of 1099 Independent Contractors
- Bring specific knowledge — Working with an independent contractor can allow you to focus on one item and do it well. Suppose you have a project that requires particularly specific design or technical skills. In that case, you will almost certainly be able to find an independent contractor who has developed a company around this.
- Provide greater flexibility — Rather than hiring a full-time employee who will stay with your business long-term; you may engage an independent contractor for a project or two or as your budget permits. This allows you to be more adaptable as the company’s goals and resources evolve.
- Less legal risk for your company – Independent contractors are not eligible for workers’ compensation, cannot file most forms of wrongful termination claims, and normally carry their professional insurance. This reduces your company’s legal liability.
- Reduces company expenses – Cost is a key consideration, and using 1099 vs. W2 employee can help you save money. Independent contractors are not required to be paid a minimum wage, overtime, or benefits. Another noteworthy W2 vs. 1099 tax distinction is that you have less paperwork when you hire independent contractors since you don’t have to withhold income taxes or pay payroll taxes.
The Difficulties of Hiring Independent Contractors
- Less control: Businesses have less control over independent freelancers, who often have more autonomy. Furthermore, they often only work for a company for a limited period, which can be disruptive.
- Legal implications: Your contract governs every aspect of your relationship with your independent contractors. So, prepare your contract carefully and get it reviewed by a legal practitioner. While you can terminate an employee at any time, you may not be able to fire an independent contractor without violating the terms of the contract.
- Insurance: If a contractor is hurt on the job, they may opt to sue the company. On the other hand, employees are protected by workers’ compensation insurance and, in most cases, cannot sue their employer for work-related injuries.
The Benefits of W2 Employees
- Dedicated to your organization – Well-treated Employees might pay off handsomely for your company. They will be loyal to your organization and will go above and above by producing exceptional work. There are many wonderful independent contractors, but you’re generally just one customer among many.
- Provide greater continuity — Employees remain with your company for the long haul and can provide help no matter what your company requires at any given time. For example, if you require someone to change their focus or contribute to a project on short notice, you can rely on your staff to assist you. Independent contractors, on the other hand, frequently specialize in one field.
- Free up the business owner’s time – Being a small company owner necessitates wearing many hats, and you may feel as if you never get a break. Having workers helps you to delegate certain responsibilities in the long run, taking them off your plate for good. This allows you to concentrate on higher-level business choices.
- Employees must be trained just once – Employees must be trained as part of their first onboarding process. And while they should be trained regularly after that, they will be aware of business standards and expectations. Because independent contractors aren’t part of your onsite team, you can’t always count on them to perform work that matches your expectations.
Hiring Employees’ Difficulties
- Higher costs: You must pay not only your employees’ salary but also your portion of their Social Security and Medicare taxes. You may also need to give staff perks such as health insurance and paid sick leave.
- Resources: You must provide your personnel with everything required to execute their tasks (unlike contractors). Employees are often situated on-site. Thus you must guarantee that there are enough workspaces for everyone.
- Employee management: You must train, manage, and inspire your staff when they work for you. Make sure you have the time to devote to this.
Finally, you can’t argue that a 1099 employee is better or worse than a W2 employee in every case. The decision between a 1099 employee and a W2 employee comes down to your company’s budget, the nature of work, and the level of control you want over the process and ultimate output.
Although their services may be more expensive than those of an employee, the skills of an independent contractor may sometimes result in a higher-quality output. However, when you hire an independent contractor, you give up control over how, when, and where they conduct their business.
That may be a no-go for some small business owners. Furthermore, many small businesses consider themselves one large family, and workers suit that paradigm better than independent contractors.
Hiring Process: 1099 vs. W-2
The hiring procedure for 1099 contractors and W-2 workers is pretty similar – except that you should make it clear from the start whether you’re looking for a full-time position in your business or a contractor.
Once you’ve employed someone, you’ll notice some subtle distinctions in the employment agreements between the two categories of workers.
Contractors, for example, usually have a contract that specifies the terms and duration of their job. W-2 employees frequently have employment agreements, although there is generally no defined length.
When you engage a 1099 contractor, they must submit Form W-9 to provide you with the information you need to record their salary on Form 1099 at the end of the year. W-2 workers must complete a W-4 form to be set up for income tax withholding.
They must also fill out papers to enroll in employer-sponsored benefits such as health insurance, workers’ compensation, or a 401(k) (k).
Is it better to be a W-2 employee or a 1099 independent contractor?
Each sort of employee has a certain purpose. For example, if you need to ramp up to meet demand when the economy recovers swiftly, 1099 contractors might be a viable alternative. Contractors can help fill in the blanks.
You may obtain a sense of your new income picture and budget without committing to long-term hiring. Businesses also frequently rely on contractors to supply specialized knowledge or services they may not require all the time.
1099 contractors are simpler to recruit since you just create an agreement and start to work. There are few legal consequences; you may let them go at any time.
Furthermore, 1099 contractors may be less expensive than recruiting a permanent full-time employee. You save on recruiting, training, onboarding, healthcare benefits, and other expenses.
Meanwhile, W-2 employees are most likely the foundation of your workforce. You put time and effort into training them, and they become an important part of your organization. They provide business stability as well as continuity for your consumers.
Managing the Costs of New Employees for Contractors and W-2s
Finding strategies to minimize expenditures is extremely important during uncertain times, regardless of how you classify your personnel.
You want to make sure you’re running your business as efficiently as possible, making the most of your W-2 employees, and bringing in contractors to provide knowledge and extra personnel when you need it the most.
A time tracking tool gives you the insights and data you need to make informed decisions about the hiring you require. A similar approach can also assist you in better managing the costs of recruits.
Limit the number of hours someone can work. You may define custom rules that limit the number of hours an employee or hire can work. This is especially useful if you manage 1099 employees—you may receive notifications if they’ve worked more hours than agreed upon and verify they’re meeting the contract’s limitations and not beyond what was agreed upon.
Onboard new employees with ease. Employees should not need substantial training to use a time tracking system.
Not sure if you want to hire 1099 or W2 employees? Take a Look at These Alternative Staffing Options
If you aren’t sure whether to recruit a 1099 or a W2 employee, two options include aspects of both: temp agencies and professional employer groups. Both choices provide you with access to a pool of skilled workers, but you won’t have to worry about them being classified as 1099s or W2 employees.
When and Why Should You Use a Staffing Agency?
Seasonal businesses or those who want to “test drive” or lease a person before hiring them full-time can consider using the services of a temp agency.
When you use a temp agency, the agency handles the hiring, interviews, background checks, payroll processing, and tax payments.
The temp agency also bills your company for the employee’s salaries and taxes, as well as a service fee for the administrative services provided by the agency.
You don’t have to worry about tax filings, workers’ compensation insurance, or other human resource difficulties because this invoice is recorded as a basic business cost on your records.
On paper, the temp agency is the formal employer of the worker, not you (unless the employment is a “direct hire”). On the other hand, you get to pick how long the employee will work for you and their day-to-day responsibilities.
This strategy is more expensive than managing your own seasonal or temp-to-hire workforce, but the time savings may more than cover the higher expense. Just don’t give yourself a false feeling of security.
Even if the temp isn’t your direct employee, you might still be legally liable if something goes wrong, such as a workplace accident. When temp agencies operate as a middleman, worker quality may suffer.
The Advantages of Using a PEO to Staff Your Company
Temporary staffing businesses are a quick answer to short-term employment issues. However, a longer-term option is known as a professional employer organization or PEO.
PEOs allow businesses to outsource HR services like payroll, workers’ compensation, and benefits while maintaining control over employees’ day-to-day obligations.
PEOs can also use the number of employees they manage across organizations to obtain better benefit alternatives than small enterprises. As is the situation with temporary staffing businesses,
PEOs demand a fee for their services, but the advantages may exceed the disadvantages.
Your business and the PEO both serve as the worker’s joint co-employers. You manage the employee daily, but the PEO is the employee’s go-to person for anything administrative or HR-related. A formal PEO agreement will specify the division of tasks.
Whether you hire a temporary agency or a PEO, you must conduct your research. Request references from the temporary agency or PEO, and then follow up with other small company owners who have utilized their services.
And, like with any business contract, you should always contact an attorney to analyze any deal with a temp agency or PEO before you sign it. This guarantees that you are not accidentally taking on obligations that you feel should be covered by the temp agency or PEO.
Is it possible for a worker to be both a 1099 and a W-2?
According to the IRS, yes. There may be times when a person works as both an independent contractor and an employee for the same company. Workers might be both in the same calendar year, either concurrently or at different periods.
The following is an example provided by the IRS:
“Joe is a custodian at a county public school.” The county considers him an employee and provides him with a Form W-2 for his services. He also owns and manages a snow plowing business that operates on evenings and weekends.
Any snow plowing services he does for the county are distinct from his duties as a custodian. As a result, the county should regard him for his snow plowing company as an independent contractor.
The county reports this income on a Form 1099-Misc in Box 7, Nonemployee Compensation.”
It is important to note that submitting a 1099 and a W-2 for the same employee may result in a tax audit. If the IRS suspects an employee has been misclassified, it will conduct such audits on employers.
How do you transition from employee to independent contractor or vice versa?
If you wish to make your contractor a full-time employee, recruit them for an available position. You may quickly convert your contractor to an employee and begin withholding and paying employment taxes by using a program like Square Payroll.
It is more difficult to convert an employee into a contractor. Because workers are presumed to be employees unless shown otherwise, transferring someone from a W-2 to 1099 may result in some IRS inquiries. Before making any changes, consult with your lawyer and accountant.
How to calculate the hourly wage disparities between W-2 and 1099 employees
Contractors might be paid at a defined sum, either hourly or by the project. Many contractors’ contracts will include payment periods and rates.
Hourly 1099 contractors may want a greater hourly rate than you do for regular workers. 1099 contractors are responsible for their taxes and perks. As a result, they may need to charge extra each hour to pay those expenses.
Employment taxes (such as Social Security and Medicare) account for 15.3 percent of workers’ total earnings. Employers pay half (7.65%) and deduct the other half from W-2 employee paychecks. 1099 contractors pay the full 15.3 percent of their earnings individually.
They must also file quarterly estimated tax payments and pay anticipated federal and state taxes every quarter. With this in mind, 1099 contractors must earn at least 7.65% more per hour to satisfy the employer portion of Social Security and Medicare taxes.
How to Calculate W-2 and 1099 Employee Salary and Benefit Rates
Contractors do not usually have access to the same benefits as W-2 employees, such as health insurance, paid time off, and other employer-provided benefits. 1099 employees must provide these perks. According to the U.S. Bureau of Labor Statistics, benefits are worth around 30% of a worker’s pay package.
According to a March 2020 estimate, the average employer cost for employee pay for civilian workers was $37.73 per hour worked.
Employers spent $25.91 on wages and salaries, while benefits cost $11.82. Paid time off, health insurance, retirement savings, and other legally mandated perks are among these advantages.
Knowing this, a 1099 contractor must earn at least 30% more than a W-2 employee to equal employee remuneration, including perks.
The tax implications of W-2s and 1099s
Your tax liabilities differ depending on whether you are a 1099 contractor or a W-2 employee. You pay 1099 workers by their contract conditions. They receive a 1099 form at the end of the year to declare their income on their taxes.
As a business owner, you are not required to withhold or pay taxes for 1099 contractors. These employees are responsible for their taxes and benefits. Because of this and the nature of their skill, 1099 contractors may be costly to recruit.
If you pay a 1099 employee $600 or more for services rendered throughout the calendar year, you must file Form 1099-NEC. After their payment, you must give the contractor a copy of this document by January 31.
A copy of this form must also be sent to the IRS. If the contractor employs their staff or subcontractors while working for you, they must file papers for these employees.
W-2 employees are paid regularly and have access to employee benefits. It is your job as a business owner to withhold taxes from their paychecks and submit those taxes to the IRS on a W-2 form.
You must also deposit federal income taxes, unemployment taxes for unemployment insurance, and Social Security and Medicare taxes for yourself and your employee. You must keep track of the taxes you deposit, employee earnings, tips, and other forms of remuneration.
Finally, you must timely deposit and declare your employment taxes. The IRS gives information on depositing and reporting W-2 employee employment taxes.
One of the first jobs you’ll face when we emerge from the COVID-19 situation is hiring new personnel. Understand the distinction between a 1099 contractor and a W-2 employee and when either is appropriate.
You’ll prevent misclassification issues, save money by putting the appropriate people in the proper jobs, and ultimately position your organization for development and success.
Staffing your company with the best employees possible is one of the most critical responsibilities you’ll face as a small business owner. The question is, though, which type of worker should you recruit? Here’s a brief recap.
- 1099 employees, often known as independent contractors, are self-employed. You can engage 1099 contractors for specific projects, but you have no control over when or how they do their work. You are not obligated to pay their Medicare and Social Security taxes, and you will not give them the same benefits as you would for a W2 employee. This might be a more affordable choice.
- W2 employees, on the other hand, demand a consistent wage, specific benefits, and more extensive management. Hiring W2 employees may incur more financial expenditures than hiring 1099 workers. However, you may prefer to have a consistent team of personnel on hand that you’ve educated and can manage according to your standards.
Before making a decision, carefully examine a few factors. This includes the work you need to be done, how fast you need it done, whether the task is a one-time or ongoing commitment, and the expenses associated with hiring 1099 vs. W2 employees.
Before making your final choice on how to consult your company’s staff, it is essential to speak with employment law and a tax consultant.
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