The Differences Between 1099 and W-2 Employees
Erez Greenberg| Nov 29, 2022
In 2021, there were about 23.9 million occasional independent workers in the United States, a jump from 12.9 million in 2017.
Now that independent contractors are on the rise, you may soon need to file taxes a little differently this spring. Even if you understand that the 1099 tax form is used to report payments made to an independent contractor, and a W-2 is used to report employee payments, understanding how to classify them can be overwhelming.
There are several legal differences between an independent contractor and a full-time employee.
How are independent contractors different from employees?
An independent contractor isn’t a full-time employee. They’re hired typically on a project to project basis or to accomplish tasks in a certain timeframe, but work independently of the business.
Essentially this means they’re responsible for providing their own tools and supplies for the job, and that employers don’t have control over how and where the contractor completes the job. When hiring independent contractors, businesses and contractors must agree to a written agreement.
A full-time employee on the other hand shows up to the office or from an agreed upon location and works on ongoing tasks. Employers have control over where, how, and when employees complete their work, and must also withhold taxes for benefits such as Social Security, health care, and so on.
Comparing 1099 Workers vs. W-2 Employees
In the chart below, you can see the major aspects that sets 1099 workers a part from W-2 employees:
|1099 Workers||W-2 Employees|
|Payroll taxes||Responsible for their own federal payroll taxes. In this two-part tax, 12.4% goes to Social Security and 2.9% to Medicare||15.3% of an individual’s wages is paid half by the employer and half by the employee for Social Security and Medicare|
|Benefits||Not entitled to healthcare, company-owned tools and resources, or company retirement plans||Entitled to retirement plans, discounts, educational resources, or health, dental, and vision insurance|
|Tax forms||Employers fill out form to show what they paid the contractor. A 1099 form won’t show taxes a contractor paid for federal, state, and self-employment purposes.||A form employers fill out to show how much employees were paid and and how much they’ve paid in taxes to the IRS for federal and state taxes.|
For all this talk of benefits and employee status, it’s important to correctly classify your staff so you know which form to submit to the IRS.
How does the IRS determine which is a 1099 worker vs a W2 Employee?
To help businesses correctly classify and identify 1099 employee requirements, the IRS created a list of questions that can determine the worker’s relationship to the company. Broadly, these help employers suss out how much control they have over the worker’s independence. The questions include a few aspects:
- Behavioral: Does the company control or have the right to control the worker’s workload or how they complete their tasks?
- Financial: Does the paying company decide any business aspects, such as how the worker is paid, who supplies tools and supplies, and whether expenses are reimbursed?
- Type of Relationship: Did both parties sign written contracts or are there employee benefits such as: a pension plan, insurance, paid time off, and more? Is the work ongoing?
Any business needs to carefully answer these questions when submitting global payroll, as an incorrect tax form could lead to serious penalties and misclassification. Penalties can include steep fines for any violations of tax codes, and misclassification can result in lawsuits and potentially, damage their reputation, making it harder to attract top talent.
If you’re unsure how to classify an employee, you can fill out an SS-8 form and send it to the IRS to help determine your workers’ status.
At this point, you may be wondering whether it’s more advantageous for your company to hire a 1099 worker or a W-2 employee. But each status can contribute to your company’s bottom line.
What Is a 1099 employee?
A 1099 employee is a contractor, not a full-time employee. Sometimes called freelancers, self-employed workers, or independent contractors, 1099 employees file their own income taxes to the IRS each year.
Since 1099 workers work for themselves, they may have several clients, not just one employee, so they provide their own workplace, tools, equipment, and anything else needed for the job. 1099 employees often charge per contact since they provide services for multiple companies at a time. A few examples of 1099 workers include:
- Freelance writers who work on an assignment basis, without set hours
- Consultants who help your company for a clear start and end date
- Gig workers who perform services receive payment through an app
- Freelance designers and developers who project by project
No matter their industry, project, or experience-level, every type of 1099 employee needs to fill out a 1099 tax form.
1099 tax form
Each tax season, businesses that hire contractors need to submit Form 1099-MISC to report compensation for non-payroll workers for a given year. Usually, individual taxpayers don’t need to fill out a 1099 form. One exception is if you own a small business and hire an independent contractor, you’d need to submit a 1099 form. Otherwise, businesses and financial institutions are responsible for filling out and submitting 1099 forms by January 31st.
Depending on the contractor’s status, there are different types of 1099 employee forms to fill out:
- Form 1099- These are documents businesses use to report payments made to an independent contractor over the last year.
- Form 1099-MISC: Miscellaneous Income – Fill out this form if you worked for someone as an independent contractor and are self-employed with several clients. For each client who paid over $600, you’ll need to fill out another 1099-MISC form. Businesses must fill out a form to send to the IRS (sometimes called Copy A), and send the contractor a copy (called Copy B)
- Form 1096 – This form is a summary of all of the 1099s you filled out and sent to the IRS by the last day in January.
Typically, taxes aren’t withheld from the income reported on 1099 forms. This is one of the major differences between those who qualify for 1099 forms—independent contractors—and full time workers, also known as W-2 employees.
Differentiating Independent Contractors from International Contractors
An independent contractor is a self-employed individual who provides services to a client or company and are usually confined to work within the country where they operate. On the other hand, an international contractor operates beyond national borders, conducting business across multiple countries.
International contractors often handle large-scale projects or ventures, requiring specialized expertise and a deeper understanding of cross-cultural and international legal intricacies. While both play significant roles in today’s globalized economy, their distinct scopes and operational environments distinguish them as unique contributors to the workforce.
What Is a W-2 employee?
Think of the W-2 employee as the most common employee status.
A W-2 employee is someone who receives a W2 tax form from their employer. W-2 employees are generally considered to be the most traditional form of employment.
W-2 employees come to work each day, fill a specific role, and receive a weekly or monthly salary. While 1099 employees work contract to contract, W-2 employees sign an agreement for an indefinite amount of time for ongoing work.
Unlike when hiring a 1099 employee, employers of record can control the workload, scope, and hours of full-time employees. Employees are also entitled to benefits such as Social Security and Medicare, which businesses withhold on the W-2 forms.
Or any other full-time position where your business can decide how the employee works, they’re likely a W-2 employee and you’ll cover any tools and training they’ll need for the job. If you’ve hired a W-2 employee, your business needs to submit a W-2 tax form.
W-2 tax form
The W-2 is a record of an employee’s compensation, benefits, and taxes withheld for a single tax year. Companies fill out a W-2 for any worker classified as a part-time or full-time employee of your business during any point of the tax year. Businesses must file W-2s for any employee who was paid $600 and over for the year or for whom you withheld taxes.
As with 1099 employees, employers have until January 31st of the following calendar year to file W-2s for their employees.
Business owners with W-2 employees must withhold a portion of Social Security and Medicare taxes from employees’ salary and must pay a matching amount.
Though the differences may feel complex, it often helps to visualize each status against the other.
Advantages and disadvantages of hiring a 1099 employee
Each employee has a different relationship with the employer, each with their own benefits and drawbacks. Let’s start with the advantages.
- Contractors come with specific expertise – You may have a single, non-recurring project that needs specific expertise. If you only need someone for a short amount of time, you can find plenty of skilled contractors who can deliver results without needing to pay for training.
- 1099 employees don’t need monitoring – Contractors usually stick to their own schedule and complete work on their own time, submitting the final result as per contract. This means teams can focus on other tasks while the contractor does their part.
- Businesses save on taxes – independent contractors file their own individual income taxes, meaning companies can save on benefits.
- You can end the partnership whenever you want – contractors can’t sue for wrongful termination so you can hire and let contractors go as needed, as long as you abide by the agreed upon contract.
- Businesses have less control – Contractors make their own schedules and may have several clients, so if you suddenly need a hand with another task, they may not be available during the hours you need.
- There’s a potential lack of loyalty – If contractors work on several projects for multiple companies, they may feel less loyal to one specific company.
- Increase in liability for workplace Injuries – Independent contractors aren’t typically protected by their employer’s insurance and may not have their own. If a worker suffers workplace injuries, they have the right to sue the employer for damages.
- Risk of misclassification – Labor laws in the United States specifically watch for companies that purposefully or unintentionally misclassify workers as independent contractors. If you misclassify a worker, your company could face fines, penalties, and back taxes.
Which type of worker should you employ?
Whether a W-2 employee or an independent contractor, both can bring value to your business, but depending on your needs, you may decide one is a better fit for your current and future goals. When deciding between the two, it’s helpful to consider:
- Is this ongoing work that will continuously impact the company or a short-term project for a pre-defined period of time?
- How urgent is the need -Is there someone available now who fits the team culture and has the necessary skills? Or can you hire a self-employed contractor while you look for the perfect fit?
- How much would you need to pay the new hire? Is it more beneficial for the company to save on salary and benefits and go with an independent contractor or freelancer?
Of course, there are also other considerations. If it’s important to your business that workers focus on pre-approved tasks and complete the work a certain way during a specific number of hours, you may want to opt for a W-2 employee.
An executive for instance typically falls under a W-2 employee. But for non-leadership roles, an experienced contractor who brings the necessary skills to a project can help you achieve more at faster rates.
As with any important business decision, weighing the pros and cons can help you make the right choice. With that, let’s take a closer look at hiring 1099 employees.
Navigating classification with Papaya Global
Misclassification is one of the most common mishaps companies can fall into when hiring contractors. Errors like these can lead to major financial consequences.
With Papaya Global, our boots-on-the-ground legal experts are with you every step of the way to ensure your workers are ALWAYS classified correctly – no matter where they’re located.
Book a demo to learn more.
Can you pay a 1099 employee hourly?
You’ll need to discuss payment terms with the person you’re hiring. Typically, you’ll agree on a contract that defines how and when they should be paid. The two most common payment methods for 1099 employees are hourly and by project.
Do 1099 employees get social security?
Everyone is entitled to Social Security. Independent contractors, however, pay the entire portion of Social Security to the IRS. Unlike with W-2 employees, employers who hire 1099 workers don’t need to withhold a portion of the worker’s salary for Social Security or Medicare.
Do you have to pay overtime to 1099 employees?
Contractors are self-employed. The Fair Labor Standards Act (FLSA) states that minimum wage and overtime requirements only apply to employees. That means 1099 workers do not need to receive compensation for working over 40 hours in a workweek.
How do 1099 employees pay taxes?
Independent contractors report their earnings to the IRS four times a year with Form 1040-ES, Estimated Tax for Individuals. This covers their federal income tax and self-employment tax liabilities. Depending on which state they’re from, they may need to also pay state and local taxes.
How many 1099 employees can a company have?
As long as businesses properly classify 1099 employees, they can hire as many independent contractors as they wish. When hiring a 1099 employee, you’ll need a written contract that states their role related to the business. Additionally, any 1099 employee who earns more than $600 a year requires to fill out 1099-MISC with the IRS and send a copy to your contractor.
What happens if you don't file the 1099 form?
If the IRS hasn’t received a 1099 form from you, they will usually notify you. If you have unpaid taxes, they will retroactively charge you penalties and interest starting on the first day they think you owed tax. Penalties can range from $50 to $280 per form.
When are 1099s due to contractors
1099 forms are due January 31st. If you paid a contractor $600 or more for services provided during the year, you’ll need to complete a 1099-NEC and send a copy to your contractor. This information needs to be sent on January 31st the year following payment.
What is a statutory employee on W-2?
A statutory employee—also called an independent contractor—is treated the same as a traditional employee for tax withholding reasons. If the employer and employee both contribute to Medicare, and Social Security and meet specific criteria, the employee is classified as statutory. Statutory employees are allowed to file claims for expenses incurred while on the job.
Can a W-2 employee be an independent contractor?
IRS guidelines allow a W-2 employee who also works as a 1099 independent contractor if the worker performs different duties that would qualify them as an independent contractor. A maintenance technician for instance can own their own supply shop. The company could contract them out to provide equipment for the company.