Depending on many factors, workers fall under one of two categories: W-2 employees or 1099 contractors. As an employer, understanding the difference between the two is essential. Generally, employees and contractors have different roles in a company, and both come with their own sets of pros and cons.
In my experience working with early-stage startups, I’ve found that choosing whether to hire a contractor or an employee comes down to the needs of your business, the nature of the work to be performed, and legal considerations. You may find a mix of both is the best solution.
|1099 vs W-2 Quick Comparison|
|Required Tax Forms||1099-NEC||W-2 Form|
|Hourly or Salary||Hourly or fixed rate per project||Hourly or salary|
|Employer Pays Payroll Taxes||❌||✅|
|Termination Rules||Simple, subject to contract||Multi-step process|
|Full- or Part-time||Generally part-time or on-demand per project||Normally a consistent full-time or part-time schedule|
In this article, I cover
- The differences between 1099 vs. W2 workers
- Pros and cons between contractors and employees
- Important factors to consider
What are the key differences between 1099 vs. W-2 workers?
1099 and W-2 workers may not seem very different at first. Both serve the company and can perform any job asked of them. However, there are a few technical and legal differences you should be aware of.
1. Taxes and Remittance
The biggest difference involves withholding taxes. As an employer, you don’t have to withhold federal or state taxes from a 1099 contractor’s fee. They receive their full fee and handle taxes on their own. You do, however, have to withhold taxes from your W-2 employee’s paycheck.
Employers must also pay their share of payroll taxes for W-2 employees, which I discuss in more detail later.
2. Control and Independence
Employers have more control over an employee than a contractor. For instance, you can decide whether they come into the office, when they work, what equipment they use, and what jobs they take.
Conversely, the contractor decides where and when they work. They choose the methods necessary to complete the assigned tasks and what tools they use. Companies are not without some control, however. While the contractor has more freedom, they must work within the guidelines and due date set by the hiring company, oftentimes outlined in the fee agreement.
3. Benefits and Protections
W-2 employees receive certain benefits and protections that contractors do not. Not all states require employers to offer benefits, but if you do offer them, only employees are entitled to them. Contractors, unless otherwise specified in the contract, do not receive benefits.
Some examples of benefits and protections that are available to W-2 employees include workers’ compensation, health benefits, unemployment insurance, company shares, sick leave, and overtime.
4. Liabilities and Responsibilities
In a similar vein, as an employer, you generally aren’t responsible or liable for the actions or injuries of your contractors the same way you are for your employees. You are subject to your contractual arrangement, of course. As such, short of the company itself being negligent when hiring or having an unsafe work environment, contractors are typically responsible for themselves.
Keep in mind, however, if you misclassify an employee as a contractor (or vise-versa), it can result in many legal fines and penalties. It’s vital to ensure you understand the differences between the two when you hire them, as well as any potential changes in your relationship going forward.
Pros and cons of 1099 and W-2 workers
Factors to consider when choosing between 1099 and W2 workers
Now that you understand the key differences between 1099 and W-2 workers, we can look at the major factors to consider when deciding whether to hire a contractor or employee.
Everyone has to pay taxes, and businesses are no exception. Businesses have to not only withhold FICA taxes from employee paychecks, but they must also pay the same percentage in FICA taxes. For example, if your employee earns $1,000, you as the employer must pay 7.65% in FICA taxes, which is approximately $76.50. Meaning you will end up spending about $1,076.50.
With an independent contractor, you do not withhold FICA taxes on their behalf and there is no employer liability for FICA tax. As a result, you do not owe 7.65% in payroll taxes. The only cost to you is the contractor fee. If they charge $1,000, you will only spend $1,000.
Payroll taxes are confusing, and it can be easy to make a costly mistake. Employers can mitigate risk and save time by outsourcing their payroll to a service provider. You can read about the top payroll service providers B2B Reviews recommends to help you avoid costly errors.
Keeping these expenses in mind will help you decide which option is better for your budget. However, payroll taxes are not the only factor to consider.
Nature of Work
Generally, employees are given more sensitive tasks, long-term jobs, and higher value projects. Contractors generally take on short-term projects, specialized tasks, and temporary or seasonal work.
Ultimately, both 1099 contractors and W-2 employees serve valuable roles in a company, and it’s up to the employer to decide what tasks they are given. You aren’t limited to giving only high-priority tasks to employees and only short-term projects to contractors.
So if the nature of their work is up to you, what difference should you expect as an employer? Well, it ties back to control and independence. Employees generally work on tasks during set office hours. Meaning you can easily check in and direct your employee’s progress. This is not the case with independent contractors. As the name suggests, they are not limited to normal hours or locations. They have the independence to choose where and when they work—the deadline being the main guide.
Sometimes, the flexible nature of their work incentivizes contractors to go above and beyond so they can continue to work under these terms. Alternatively, some contractors embrace the freedom too strongly and perform poorly as a result. Keep this in mind when hiring a contractor.
As an employer, it’s important for you to consider how you want a task handled before you assign it. Both types will get the job done, but the process will look different.
Cost and Budget
Overall, contractors cost less than employees. Payroll taxes do not apply to contractors. You also don’t need to provide benefits or workers compensation. The only cost will be the contractor’s fee.
However, contractors usually aren’t as involved in the business. Employees, generally, have more care for and understanding of the business. You can build long-lasting relationships with your employees. On top of that, employees are usually more invested in the company, staying for years while contractors take on a temporary and distant role.
There are always exceptions, of course, but this dynamic is important to keep in mind. While contractors cost less, employees may have a greater impact on your company’s culture. It’s up to you what’s more important.
Legal and Regulatory Compliance
According to the federal labor law protections, employees receive certain rights that contractors do not. Some of these protections include minimum wage guarantee, overtime pay, and the age minors can work.
If an employer breaks these laws, employees can take legal action. Contractors do not have avenues for such recourse, unless otherwise stated in their contract. Building a solid independent contractor agreement can help both you and the contractor protect yourselves.
Your Business Strategy and Goals
Deciding between a 1099 contractor and a W-2 employee may ultimately come down to what is currently most valuable to you and your business.
If your business is running on a shoe-string budget, you may find a 1099 worker best. You can easily scale them on and off and save tax money.
However, if you need the security of a long-term business relationship, an employee will be better. While employees can quit within two week’s notice, full-time employment is often viewed as a commitment, attracting workers who are loyal and productive long-term.
The Bottom Line
Contractors and employees are classified differently by the IRS, receiving different tax forms and benefits. Contractors receive 1099 tax forms, do not have taxes withheld, and have more control and independence over the way they go about their work. Employees receive W-2 tax forms, have taxes withheld, are subject to FICA payroll tax, and adhere to the schedule set in place by the employer.
Contractors are also cheaper than employees since employers do not have to pay payroll taxes or offer benefits. With contractors, there is less risk of being sued or facing litigation if payroll compliance laws are broken.
However, employees bring stability and improve company culture. When you work with the same people for a while, you build stronger relationships. When people work together and share the same goal, businesses flourish.
Overall, choosing whether to hire a contractor or an employee comes down to the needs of your business. You may find a mix of both is the best solution. As your company grows, you can reassess your needs and budget to determine who is best to hire, which may differ by circumstance.
If you are uncertain about which option is best for your business, it’s advisable to consult with an employment attorney or an accountant who can provide guidance based on your specific circumstances and local regulations. They can help you make the right decision and ensure that you comply with all legal requirements.