When to Issue a 1099 Contract vs. a W2
As a company that works closely with business directors and human resources managers, we believe that it is our duty to advise our clients with up-to-date and relevant information about how to best care for their people. After all, a business consists of the people who make it. Therefore, it’s important to know the ins and outs of how to best support your employees. Of course, this comes with the logistics of payment and compensation.
Nowadays, companies are increasingly employing contractors to do the work that used to be done entirely by full-time staffers (Northwestern Mutual). Because of this, it can often be difficult to tell employees and contractors apart. But as a business leader and/or owner, you should understand the significant differences between the two. With various numbers and letters, it can be easy to mix the two up. However, if an employer provides the wrong form to an employee, it could result in consequences. Luckily, we’re here to save you the headache of confusion (and a potential penalty from the IRS).
Image from GG CPA Services
Fundera states that 1099 employees are self-employed independent contractors who receive payment in accordance with the terms of their contract and get a 1099 form to report income on their tax return. On the other hand, A W2 employee receives a regular wage and employee benefits. The employer withholds income taxes from the employee’s paycheck and has a significant degree of control over the employee’s work.
How to Determine Whether Your Employees Are 1099 vs. W2 Employees
Hiring 1099 workers—or independent contractors as they are more commonly known—can help you cut back on costs and legal responsibilities. Usually, it is much easier to pay a contractor than it is to administer payroll and handle other HR functions required of a business with employees (Fundera).
The IRS considers three major categories in determining whether workers are employees or independent contractors (APS):
- 1. Behavioral – Can your business control what, where, how, and when the worker carries out their job?
- 2. Financial – Who controls the economic aspects of the worker’s job? What’s the method of payment (e.g. a regular salary or a flat fee)?
- 3. Type of relationship – Do you provide this worker with employee benefits? What are the length and terms of this relationship, as outlined in a contract, employment agreement, other documentation?
Essentially, what classification goes down to is the level of control a business has over the worker. If the company controls most of the person’s work, then the worker is most likely a W2 employee. If the person has a good degree of independence, they’re most likely a 1099 independent contractor.
Advantages and Disadvantages of 1099
If you are managing a startup or small business, it is likely that you will lean towards hiring 1099 workers. By hiring independent contractors instead of putting employees on the payroll, business owners can reap the benefits of no income tax withholdings, no employment taxes, no liability for acts of employees, no federal and state discrimination laws covering only employees, and no obligation to offer benefits (Lawfirms).
However, there are also some disadvantages of hiring 1099 workers. For instance, the basic agreement between employers and 1099 workers is that independent contractors can choose whether or not they want to come to work without the fear of losing employment. They have the ability to control their own hours and can typically execute tasks on their own terms without having to adhere to strict company policies. The work that they do is more so on their own time and to their own discretion as long as they are meeting the expectations agreed upon by themselves and the employer.
We hope that this information sheds light on what type of contract is suitable for your company and employees. Understanding the differences between when it is ideal to issue a W2 versus 1099 will allow you to make the decision that is best for both parties. Most importantly, it will allow you to ensure that you are operating in a legally sound and secure way.