Hiring 1099 Vs. W-2 Employees

1099 Vs. W-2 Employees: How to Choose the Right Workers for Your Business

Staffing a small business requires a lot of thought. Like all businesses, small businesses have the choice of contracting temporary staff or bringing on permanent employees to fill operational needs.

Two common types of workers are 1099 and W-2, which refer to the Internal Revenue Service (IRS) forms associated with each. As the two groups are vastly differently, it’s important for small business owners to think through which staffing model will best help them achieve their goals. Additionally, understanding the difference between employee classifications and associated financial implications is crucial to being properly prepared for tax season and avoiding costly penalties.

 

1099 Workers: A Flexible Option

What is a 1099 employee? Workers who are classified as 1099 are essentially independent contractors. Sometimes referred to as the gig economy, this group has grown exponentially since the start of the COVID-19 pandemic. In December 2020 it was estimated that 35% of Americans were involved in the gig economy.

This shift provides a big opportunity for small businesses. From a financial and flexibility standpoint, utilizing 1099 workers can be quite appealing. Long-term commitments are not required with 1099 workers. You may not have an ongoing need, and thus won’t have to pay these workers when their services aren’t needed. Your company also won’t have the responsibility of providing vacation, insurance, and other benefits typically expected by salaried employees.

1099 workers are often a good fit for companies with unpredictable or seasonal needs, such as a landscaping company that is busier during the spring and summer months or a gift company with a holiday boom.

Wages are negotiable with 1099 employees, and your company does not have to withhold taxes or pay taxes on the payments made to independent contractors. Both of these factors can be beneficial in managing cash flow and cutting costs.

 

Specialized Labor May Come at a Cost

It’s important to note that independent doesn’t equate to unskilled. In fact, it can be quite the opposite. Independent contractors are often highly skilled and specialized, providing an opportunity for small businesses to tap into their expertise for a specific project or time period.

However, this arrangement can have some limitations. Workers with 1099 jobs often have other commitments, such as working for other clients or choosing to limit their hours for personal reasons. Thus, they may not be available when you need them for a project and often require training, consuming time and resources.

Additionally, this relationship can open your company up to risk. While you can protect yourself by drawing up standard forms such as non-compete contracts and non-disclosure agreements, a 1099 worker is not subject to your company’s rules and policies in the same way that a W-2 employee is.

Consider also that while you don’t have to provide 1099 workers with equipment such as computers, there is inherent risk in allowing your IP and internal knowledge outside of your company’s boundaries. For example, an outside worker’s network or Internet connection may not be as secure as yours, inadvertently exposing confidential data.

 

Pros and Cons of 1099 Workers

 

W2 Employees: Planning for the Long-Term

Any worker who is not a 1099 worker is considered a W-2 employee. W-2 employees can be full-time or part-time, and offer companies more stability and security than a 1099 contract worker. These employees can be expected to work certain hours and be available to their employers as needed. Additionally, you have greater control in asking them to abide by your company’s preferences and policies.

W2 employees often work well for companies with ongoing needs. If there is a job to be done every day, it may make more sense to hire staff who can be trained and attend to the responsibilities on a regular basis rather than relying on temporary staff.

However, this increased accountability comes at a cost. As opposed to 1099 workers where companies do not withhold or pay tax on their rates, for W-2 employees, companies are required to withhold and pay income taxes, Social Security, and Medicare taxes as well as pay unemployment tax on wages paid. Companies are also required to file payroll taxes for W-2 workers.

Employees will also expect some benefits, such as paid vacation and health insurance. While these benefits can vary depending on how many hours the employee works, there is a trend towards more states requiring private sector employers to provide paid sick leave, even for part-time employees.

 

Pros and Cons of W2 Workers

 

Risks of Misclassifying Employees

Understanding the differences between a 1099 vs w2 employees and labelling them appropriately can be critically important to your business. Misclassifying an independent contractor as an employee or vice versa can trigger financial penalties from the IRS, and it happens more than you might think. It’s estimated that 3.4 million employees have been incorrectly classified as independent contractors.

The IRS takes these misclassifications very seriously. Penalties can include:

  • $50 for every W-2 the employer failed to file correctly
  • 1.5% of wages
  • 40% of FICA taxes that were not withheld from the employee
  • 100% of the FICA taxes the employer should have paid

 

When it comes to working through these business nuances and preparing for tax season, a Certified Public Account (CPA) can be a valuable resource. The IRS also provides detailed information and common law rules to determine if an individual is an employee or an independent contractor.

 

Additional Resources for Small Business Owners

Dun & Bradstreet offers educational resources and insights to help small business owners realize their dreams of becoming entrepreneurs and growing successful businesses. For inspiration on using data to better understand employment trends and staffing needs, check out this episode of our The Power of Data podcast.

 

 

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