We’ve got an important post for you today, because we’re going to discuss whether you should pay your employees through as a contractor or as a regular wage.
In other words, we’re going to debate a 1099 vs W2 and which one may be best for your business. This is because selecting between these two options will determine your tax outcomes for both you and your employees.
So if you’re just getting started or trying to reevaluate your current infrastructure then this post is for you.
Now I know a lot of guys out there, especially when you’re in the early stages of starting up, are wondering how to bring on their first employees.
Which is if you’re at this point, it likely means that your business is growing which is not an easy feat to accomplish.
So i just want to take a moment to congratulate you.
Okay now that’s over. Things get real.
You see, when you hire an employee, that brings on a lot of other tasks.
You have onboarding, training, feedback, supervising and more.
But the biggest task is pay. Because if we’re being honest, your payroll is the number one reason why people would even consider working with you.
And as we know, business is tough, so you want to be able to pay competitively and get good talent. We want to maximize our pay structure between contractors and employees so we can get the best outcomes for everyone.
So today in this post, we’re going to discuss 1099 vs W2 and which one may be better for your business.
Okay, so here’s what we’re going to cover.
#1 – What are going to define what a 1099 worker is and what a w2 worker is.
#2 – We are going to clearly define the differences.
#3 – We are going to look at what is best for your business.
#4 – And lastly, we’re going to wrap up by looking at some scenarios that may help you make final decisions.
Alright now we’ve got that out of the way, lets go ahead and dive in by defining what is a 1099 worker and what is a W2 worker.
What is a 1099 Worker?
A 1099 worker, or also referred to as an independent contractor, generally provides specific services as defined by a written contract.
Freelancers and consultants are often declared as an independent contractor and thus are self employed. So they are business owners themselves who likely work with multiple clients.
Independent contractors have complete control over how they execute your contract. So if they wanted to hire a team to help then they could. Basically, they control their own profits and expenses.
Now usually, a business will engage with an independent contractor for a specific period of time and with a specific contract. But that engagement can be renewed as many times as the businesses would like.
And since your level of control is relatively, your level of financial and legal responsibility is also low.
You don’t have to pay payroll taxes or benefits that you may give a W2 worker such as health insurance, PTO or even overtime.
So by hiring an independent contractor, you’re able to save some money, but you lose some flexibility because you have to stick to the agreement or contract.
What is a W2 Worker?
A W2 employee is what we like to think of as a typical regular waged employee.
Unlike independent contractors, W2 workers are not business owners. They work solely for your company. Also, W2 workers can participate in all your employee benefit programs, and work according to your current business’s needs and schedule.
And if you’re not happy with their performance on the job, most states will allow you to terminate the relationship. Whereas with an independent contractor, you are expected to uphold the agreement for the specific time period.
So, you gain a tremendous amount of flexibility by hiring a W2 employee. And unless you classify your worker as an independent contractor, the default classification for someone working for your business is a W2 Employee.
Now there are some laws & regulations for W2 employees.
Firstly, and of course, you have to pay a minimum wage for the time they’ve worked, which is set by state and federal laws.
Also, you’re expected to withhold taxes on behalf of your employee such as social security and Medicare taxes..
You’re expected to pay payroll taxes as an employer.
And as we mentioned earlier, benefits such as:
- health insurance
- retirement contributions
- and paid time off
…can be other incurred expenses. Whereas an independent contractor is expected to handle those benefits on their own.
And since this is the case, you may find that independent contractors are charging a premium hourly rate or fixed fees to account for these other expenses.
Ok let’s move on to section 2 of this post which is to determine the difference between 1099 vs W2 workers.
Differences Between 1099 and W2 Workers
Now both are named after their respective tax forms. Companies provide a form 1099-misc to independent contractors and companies file a Form W2 on behalf of their employees.
As we know, having the right workers are vital to your success as a small business. So the question isn’t should you hire workers, the questions is how should you classify them.
And it’s important to classify correctly because if you misclassify an employee as an independent contractor, for example, then you could be subject to thousands of dollars in fines and legal fees.
And I want to cut down some of the confusion and help with this classification.
So we’re going to look at how the 3 major categories that the IRS uses when determining 1099 vs W2 workers.
1. The first category to think about is the behavior category.
So basically how does the relationship between the company and worker behave?
You should ask yourself a question like “Does the business control what, where, how and when, the worker carries out the job?”
And so the more control and flexibility you have, that fits closer to the W2 category.
2. The next category is the financial relationship.
So asking a question like “Who controls the economics of the worker’s job?” Right.. like are you setting the salary or is the worker explaining his fees?
Also, what’s the payment method? Is it an hourly salary or is it more of a fixed fee?
So in a financial relationship, if the worker is setting more of the fees, it’s closer to 1099 or an independent contractor relationship.
3. And lastly is looking at the overall type of relationship.
So is this worker getting benefits, is there an undetermined time period for the relationship? Is there an agreement in place?
The answers to these questions will help determine the type of relationship.
So what it all boils down to is the level of control that a business has over the worker. If the worker has a lot of independence with little oversight, they are most likely an independent contractor.
If the business has a lot of control of the work, they are most likely a W2 employee.
Now if you’re still unsure about how to classify your employees then you can use a form SS-8 and the IRS will help you with your classification. But it can take about 6 months to hear back.
So now that you understand the difference, let’s talk about the question you’ve probably already been asking yourself which is number three…
Between 1099 vs W2 Employee Which One is the Best For Your Business?
Of course, as small businesses, costs are really really important. And with employees you are going to have employment taxes, workers compensation insurance, office expenses and etc., which can quickly eat away any profits.
So most people will start with hiring independent contractors.
However.. you HAVE to factor in some opportunity costs because that could level the playing field for you for both options.
So let’s look at some advantages of 1099 independent contractors.
Benefits of Hiring 1099 Independent Contractors
#1 – They can bring some specialized expertise.
The biggest benefit is that working with an independent contractor or business is that they normally focus on one area and they do it really well.
So if you have a specific project that is short-term, they can be great. For example, if you’re moving into a new office and need some help with layout and design then hiring an independent project manager for this would be ideal.
#2 – You have more budget flexibility.
Instead of hiring someone who you have to pay for the long haul, you can set a predefined budget and outcome. This is so that you are being as cost efficient as possible.
#3 – They come with less legal risk.
You don’t have to get workers compensation coverage for independent contractors.
In fact, most of the time they have their own insurance, which greatly limits your exposure to legal issues.
#4 – You will have lower volume of administrative work.
As we mentioned, you don’t have many of the laws that come with a W2 worker.
So you don’t have to worry about calculating employment taxes or putting together benefit plans and making sure everything is administered correctly.
So those are some of the major benefits in my opinion. Sounds pretty sweet, right?
Well hold on because W2 employees have four great benefits you should consider as well.
Advantages of Hiring W2 Employees
#1 – They are committed to your company.
This is probably my favorite because when you create a great culture, employees can thrive beyond their job description. They can work as an extension of you and are invested in the success of the business.
And the performance is clear and measurable. You never have to wonder if they are going to work today or even respond to you because you set the schedule.
Now there are some great independent contractors out there as well, but you may just be one of many clients for them.
#2 – They offer more continuity.
Because working with independent contracts is short-term, when you have to hire a new one, you will likely have to explain who your company is, what you do, your brand and your vision…
Again, and again, and again, and again…
However, a W2 employee can easily shift projects because they have a long term relationship with you and will naturally understand the business.
So this ultimately saves you a lot of hours in just explaining to people what your business does.
#3 – The employees’ tasks are more flexible.
Usually, independent contractors are good at one or two things, but not when running a business, especially a growing one.
There are hundreds of other tasks like answering phones, training others, customer service, billing, collections and more. The advantage of W2 employees is that they can help out with some of these small yet important tasks as well.
So overall, no one can say whether independent contractors are better than w2 employees. It really just depends on your budget, your timeline and your control over the outcomes.
Alright, in this last section of this post, let’s look at scenarios of when to hire a 1099 vs W2 worker.
When to Hire a 1099 vs a W2 Worker?
1. First scenario, let’s say that you are working on a short-term project and need temporary help to complete it. Should you hire a 1099 or w2 employee?
Well since it’s short term, an independent contractor would likely be best suited to handle this.
2. How about this scenario- you own a brick and mortar store and your sales increase during a busy season. Which employee classification suits best?
In this case, a W2 employee would be best because you need someone to be on a very specific schedule that can be adjusted.
3. Here’s a third scenario, there is a function in your business like taxes & bookkeeping that needs to be taken care of regularly and takes a few hours to complete.
Now this could go both ways.
But if you don’t have enough hours for this task to be full time, you likely should hire an independent contractor or business, instead of paying for a long-term and full-time employee.
4. And here’s one last scenario. Let’s say there is a distinct process that must be followed in order to produce a quality product or service- which is better W2 or 1099?
If you said W2 then you are correct!
Delivering your service or product is a long term project for an undefined period of time (and hopefully that’s for a long time).
So based on these scenarios, you can easily see how sometimes it makes sense to hire an employee, and other times it makes sense to hire a 1099 contractor.
Ultimately, think about what you need to accomplish instead of only focusing on costs. Because there will be an opportunity cost of having to make the switch eventually.
In conclusion, my opinion is that if you are in a position where you’re just getting started and you’re not confident in the long term outlook of the business, then you should consider finding really good independent contractors or businesses to work with.
On the other hand, if you have an extreme amount of confidence or investment in the long term outlook of the business, you should consider finding W2 employees to work with instead.
But, if the tasks you need help with are related to your financial management such as bookkeeping, accounting, business taxes, CFO and such, then what you need is a reliable accounting firm. Contact us today!