W-2 v. 1099: Are Employees or Contractors Best for Your Small Business?
The Difference Between W-2 and 1099 Workers
SEP 28, 2021
The first key difference between them is the actual reporting, done on either a W-2 form and a 1099 form. A 1099 form is issued to an independent contractor to report the payments a company makes to the contractor and to inform the IRS. The contractor then reports and pays their taxes independently since they are considered self-employed. A W-2 form is given to an hourly or salaried employee to report their income and the payroll taxes withheld along with certain benefits.
Knowing which form to provide the workers at the end of the year depends on correctly classifying them. To better understand this process, consider how the IRS classifies workers. According to the IRS, an employee is anyone who performs services for you if you can control what is required and how it will be done. For example, even if an employee requires little assistance due to their skills and experience, if their schedule, work and overall performance is directed and managed by an assigned supervisor for example, they are likely an employee.
An independent contractor can be defined as anyone who offers their services to other businesses or the general public. If the payer has the right to control or direct only the result of the work and not what will be done, or HOW it will be done, that generally defines them as an independent contractor. However, defining the difference between employee and independent contractor can get a bit complicated, depending on the situation.
EMPLOYEE VS. CONTRACTOR
Accurately classifying and keeping track of employees and contractors is essential, not only to keep payroll running smoothly but to abide by federal, state and local tax law. A Workers’ classification impacts how you pay employer taxes and how your employees are equipped to pay their federal income tax, social security, medicare taxes, etc.
No single factor defines whether a worker is an employee or contractor, so it is important to define the distinction on a case-by-case basis. Consider the entire relationship and examine the degree or extent of the right to direct and control. These control factors will help you determine the difference between a W2 employee and a 1099 contractor.
If your worker receives extensive training and instruction on how their work is to be completed, that person may be an employee. Instructions include when and where to work, what tools or equipment to use, what order or sequence to follow when performing the work, etc.
If a worker receives less extensive training or instruction, that person may be an independent contractor. Time and place may be less important than how the actual work is performed. However, the amount of instruction will vary depending on the type of work performed. Even if you, the employer, give no instructions, behavioral control may apply if you have the contractual right to control how the individual achieves work results.
DIGGING INTO THE W-2 EMPLOYEE
W-2 employees may also receive benefits, such as paid training, health insurance (usually for full-time employees), sick/vacation pay, and are reimbursed for employment expenses. Quality benefits can often attract and retain high performers as well as increase morale. W-2 employees are with a business for an indefinite period of time, not on a per-project basis. Employees benefit from job security, and employers receive value by having consistent workers.
Having consistent workers as employees allows employers to easily delegate tasks and free up their time. Employers mainly enjoy this benefit as they have more control over an employee. Employers dictate an employee’s training, daily schedule, and tasks. If an employer needs to have a task completed in a unique way, hiring an employee could be a wise move. Also, some employees prefer stability and a predictable schedule and compensation plan.
MORE ON THE 1099 CONTRACTOR
Form 1099 is used to record many items, but Form 1099-MISC records an independent contractor’s earnings. Employers use Form 1099-MISC to inform the IRS and contractor how much they paid a contractor. This form contains many important pieces of information like a contractor’s tax identification number, payor’s information, and any withheld taxes.
A business is required to file this form if they paid a contractor at least $600 in gross payments, among others. Independent contractors are also referred to as freelancers or consultants and are considered self-employed by the IRS.
Since they are considered self-employed, many individual contractors refer to themselves as small-business owners.
There may be some downsides for business owners and workers in this scenario. Contractors can work when they want and have little supervision. This could be tough for an employer who wants tasks completed a certain way. Contract workers have more freedom, but their projects can be terminated with short notice. Thus, most freelancers are always on the hunt for new clients.
Sometimes, companies accidentally or even intentionally mislabel W-2 and 1099 workers to avoid employer reporting requirements or paying employee benefits. Not paying employee benefits might save money in the short term, but it will likely costs more over the long run if a problem arises. For example, misclassified employees don’t have access to entitled benefits, which can hurt morale and productivity. Mislabeling can be even considered illegal and is punishable by IRS levied fines and even jail time for overly guilty businesses.
OUTSOURCE THE SOLUTION WITH PAYROLL VAULT
The line between employees and contractors can be tricky to navigate, so Payroll Vault is ready to provide resources that guide business owners to the most accurate treatment and design a payment process that manages all the proper reporting and preparation of necessary tax forms to keep your business running accurately and smoothly.
Between daily operations and the unpredictable nature of business ownership, it can be difficult to manage payroll without the assistance of qualified experts.
At Payroll Vault, we pride ourselves on being industry leaders who prioritize efficiency and service, and we are here to help. Reach out today.