Differences Explained: 1099 Contractors vs. W-2 Employees

Once you start hiring people to help you with your workload, you’ll face decisions about their type of employment. You might decide to hire someone full-time. Other times, a contractor might be a better option.

It’s important to understand the difference between an independent contractor and an employee. It will affect how they can contribute to your company and how you’ll be paying them. You’ll also need to understand the difference between 1099 and W-2 forms, to maintain compliance when tax season comes.

Here’s all you need to know about 1099 contractors and W-2 employees. Let’s discuss the benefits of each, and what you should expect when hiring either.

What is the difference between an independent contractor and an employee?

There are several differences between a contractor and an employee that every employer should know about.

When you hire an employee, you generally hire them full or part-time, and you get to direct what work they will do for your company. You get to decide when they work, what they will work on, and how they complete the job.

On the other hand, independent contractors work on a per-contract basis. With contractors, you need to define the requirements upfront and agree on deadlines, deliverables, and price. This cooperation may be a bit limiting and needs more upfront planning. But, once the contract concludes, your obligations toward the contractor end.

Both can perform work for your company. But, here are several things you should consider:

1. Level of autonomy

When you hire someone full-time, you have all the liberty to direct their workload in full. You can set the rules on when, where, and how your employee should work. Your employee can also take on extra responsibilities. They will follow the company guidelines and your instructions when performing the job.

Independent contractors are their own bosses. An independent contractor will set their own hours and wages. Unlike employees, they commonly follow a set of best practices for the job rather than adhering to your guidelines.

Independent contractors may or may not take into consideration your preferences and requirements. They are more autonomous when it comes to their workload. If you prefer to have more control over the work, an employee might be a better option. But, independent contractors will likely complete the task quickly and effectively. They also don't need or appreciate too much supervision.

2. Expertise

The main reason why employers decide to hire independent contractors is that they usually come with a specific skill set. They have a niche expertise your company may need at the moment. You can trust them to complete the work much faster when compared to having to train one of your employees.

Independent contractors also often work on a need-to-know basis, so you can also skip the detailed onboarding process. In short, you can count on independent contractors to complete the job much faster than a regular employee.

3. Loyalty

When you compare employees with independent contractors, loyalty stands out as a key difference. You'll quickly notice that contractors don’t have the same sense of loyalty to your company as your employees do.

With employees, you are working toward a common goal. A 1099 contractor will focus on getting the work done quickly and efficiently and getting paid for it. An independent contractor will apply themselves to complete their part of the job. But, they might not have an interest in the bigger picture when it comes to your company.

Also, no provision stops the contractor from working with many companies at the same time. Unless you sign an NDA or similar agreement, the independent contractor may use the experience gained for other projects.

There is also the question of IP rights, which you should also discuss with an independent contractor upfront. With an employee, the intellectual property rights automatically belong to the company. This is not the case with independent contractors.

4. Flexibility

Another great benefit of hiring independent contractors is the flexibility. You can hire independent contractors for jobs and tasks that are short-term. You can rely on them for tasks that take a few hours to complete, for example. Or, when hiring someone full-time might not be the most cost-effective solution.

Other times it might be a one-off project you won’t need in the future. Hiring independent contractors might also be a good idea if you need specific expertise.

Once your contract is complete, you are no longer obligated to the independent contractor. Unless you have more work for them, they may look for projects and contracts elsewhere. Terminating a full-time employee is a much more complex process. Just like they didn’t need special onboarding, you don’t need to offboard independent contractors, among other things.

5. Price

Independent contractors may be more cost-effective depending on the type of work you are looking to hire for. If you need tasks covered occasionally, hiring an independent contractor might be a good option.

As you don’t have to pay taxes and benefits for an independent contractor, they may seem like a cheaper choice. However, independent contractors still have to pay those themselves. So, their hourly wages will likely resemble this increase when compared to the hourly wage of an employee.

So, if you need them occasionally, hiring them as an employee might be more expensive. But, if you have to rehire them often, hiring them full-time might be more cost-effective. If you do need them full-time, and they agree on your offer, converting them into an employee will save you a lot in the long run.

What is the difference between 1099 vs W-2?

Now that the difference between the two is clear, you need to understand how the end-of-year tax forms fit in. In terms of 1099 vs W-2, as a company, you send one or the other to your employees or independent contractors.

1099 Form vs. W-2 Form

W-2 form is sent to your employees each year, by the end of January. This form includes information they need to submit their taxes, such as their wages and taxes withheld.

1099 Form, more precisely, 1099-NEC is sent to independent contractors. As a company, you need to send a 1099-NEC to each contractor you’ve paid $600 or more in the year by the end of January.

To be able to do this, you should first ask your contractor to send you a W-9 form. It will include all the relevant information you need to fill out and send 1099-NEC. The contractor will then use the information from the 1099 to file the income and expenses for their business.

Employee classification

It's important to understand the difference between these tax forms. But, you also need to keep in mind the parameters that separate independent contractors from employees.

Employee misclassification can be a serious threat to a company. In essence, for employees, you have to provide salary, withhold taxes, and provide statutory benefits. This doesn’t apply to independent contractors, who, in return, have a level of freedom not applicable to employees.

The IRS has a strict set of guidelines on how to classify your employees. Some of the lines may be a bit blurred due to the growing gig economy. Still, it’s important to understand how to classify your employees to maintain compliance.

Several factors come into play to discern whether someone is an employee or an independent contractor. These revolve around the level of independence they have while performing the work. If someone is working full-time and receives a fixed salary on a monthly or weekly basis, they are likely an employee. Independent contractors get to set their hours and get paid once the contract is completed.

An employee typically works from an office. They use the company’s equipment and follow the company’s guidelines rather than a universal set of best practices. Their daily workload may change, and they may take on extra work.

An independent contractor has the right to choose where they work, how they will complete the task, and which tools they want to use or work on. Whether they will accept more work is up to them, and they will likely work for many companies at the same time.

What happens if I have misclassified an employee?

If you find that your independent contractor leans more towards W-2 than 1099, you should talk to them about hiring them as employees. There are many benefits to having an employee, and it will be a more cost-effective option in the long run.

Misclassifying an employee may lead to serious penalties and fees. Typically, the employer has to pay backdated social security or pension contributions. The employer will also likely have to pay retroactive benefits, salary, overtime, and leave pay. There may also be penalties and fees included.

Some countries place a significant personal responsibility on employers for misclassifying an employee. It can lead to fining the directors that have misclassified an employee, and in some countries, even imprisonment.

If you are unsure whether your contractor is an employee, consult the IRS guidelines or your global payroll provider. They will provide you with insight that is relevant to your business and current situation.

Examples of 1099 vs. W-2 Workers

It may be difficult to understand whether you should hire someone as an employee or contractor. So here are some real-life examples to help you pinpoint the difference.

You might hire someone as a 1099 if they are:

1. Consultants that assist your company on projects that have a clear start and end date.

2. Web designers and developers, who work on a project basis.

3. Freelance writers who charge you per article rather than per hour.

But, you should hire all these as W-2 workers if:

1. The consultants are working more as a project manager than a one-time consultant.

2. You might decide to hire web designers full-time if you need ongoing designs for your marketing team. Or, if you would like upgrades or ongoing maintenance done on your website or app, consider hiring web developers as W-2.

3. If you need your writers to have scheduled work hours on an ongoing basis.

The costs of W-2 vs 1099

There is a common misconception that 1099 contractors are cheaper than hiring someone full-time. The truth is that cost-effectiveness depends on an individual, case-by-case basis.

Most of the time, the hourly rate for the independent contractor and an employee ends up the same. Business owners generally think of a contractor to be cheaper. This is because they aren’t obligated to withhold taxes or provide pension and health insurance.

However, the contractor still pays for these, so they will likely calculate those into their monthly or hourly rate. The same goes for work equipment, HR activities, and other business-related tasks. They will calculate the typical tasks of an employer into their price, and it often affects the hourly rate.

For example, let’s say you have a W-2 employee, whose base salary is $100,000 per year. When you add the benefits, which normally range from 15-30%, that employee can cost your company up to $130,000. When divided by the number of hours worked, your employee costs you somewhere around $62 per hour.

But, your independent contractor also has the same benefits and contributions to meet. Also, on average, independent contractors pay more in taxes. There’s also the cost of the benefits typically provided to an employee. They have to include sick leaves, vacation days, cost of equipment, time spent on HR activities, office space, and much more in their hourly rate.

To meet the base salary of $100,000, your independent contractor will likely have to charge you more than $80 per hour to meet the employee's salary. If you hire an independent contractor for a full-time project that lasts a year, you'd be paying more than $166,000.

In the long run, hiring an independent contractor might be more expensive than having someone onboard full-time.

Should you hire a W-2 or 1099?

Whether you should hire an employee or go with an independent contractor depends on the current and long-term business needs. They each have pros and cons, and it’s important to evaluate those realistically before hiring.

Hiring an independent contractor might be a quick and cost-effective way to complete the job if you need someone for occasional work. They also often have useful niche expertise and can get started on projects quickly as there is no need for a lengthy onboarding process.

Yet, you might consider converting them into an employee if you rely on your independent contractor often. They may show interest in being a more permanent member of the team, which is another good reason to convert them to an employee.

Is it better to be a W-2 or 1099?

Whether you should be a 1099 contractor or seek employment as a W-2 somewhere depends on your personal preferences.

As an independent contractor, you are your boss. You’ll likely have to establish a solo proprietorship and pay your benefits and taxes. As an employee, you can count on your employer to provide wages and benefits instead.

As a 1099 contractor, you have more liberty in choosing who you work for, how, and when. A contractor can have more than one employer at the same time. You need strong organizational skills to manage time and money while working on multiple projects.

As a W-2 employee, you are eligible for some benefits. This includes statutory benefits, but also pension, healthcare, and other perks.

As an independent contractor, you’ll have to find ways to compensate for some of these benefits. You need to calculate potential time off and sick days into your hourly rate. You’ll also have to find systems for finding new customers and managing invoices and finances. As an independent contractor, you'll have to make adjustments that employees don’t have to worry about.

If you want more independence in your work, working as a 1099 contractor might be a good fit for you. If you like the comfort of having a regular salary and accompanying benefits, then a W-2 employee might be a better option.

FAQ:

Is it better to be paid 1099 or W-2?

This depends on your employer-employee relationship. As a contractor under 1099, you are responsible for meeting 100% of Medicare and Social Security taxes quarterly. As a W-2 employee, you need to meet 50% of those, while the rest employers take out of the paycheck.

Both independent contractors and employees need to pay income tax, but the rate varies depending on their tax bracket.

Why was I given a 1099 instead of a W-2?

If you were issued a 1099 instead of a W-2, it means that your employer classified you as a contractor. You should get familiar with the financial and legal differences between a 1099 and a W-2. As an independent contractor, you have to pay your taxes, including the self-employment tax. Consult with your tax advisor to understand what this difference means for you.

Does 1099 get taxed less?

Independent contractors are generally taxed more than employees, as there isn’t an employer who’ll cover half of the taxes. For employees, 7.65% of employee’s income is withheld automatically for taxes to cover Social Security and Medicare taxes. The employer also contributes the same amount per employee.

Since the independent contractor is both the employer and employee, the entirety of those taxes falls on them. It means they have to contribute both halves, which comes close to 15.3% of their income.