Understanding the Difference Between 1099 and W-2: Your Guide to Mastering Worker Classification

It’s go time. You’ve set your objectives. Mapped out your strategy. The only things left to do are find the people who can help you achieve your goals and set them to work. The good news is that you have options. You don’t necessarily have to go the traditional — and potentially time-consuming — route by hiring employees. Bringing on 1099 workers could be a better fit.

So how can you know for sure? Understanding the differences, and pros and cons between 1099 workers and W-2 employees is a good place to start. Once you do, you can make an informed decision about which type of worker you’ll hire, and avoid any surprise issues that could derail your progress down the line. You can also rest easy knowing that anyone you hire is properly classified and you’re in compliance with federal and state regulations.

After reading this blog, you’ll understand:

1. The difference between 1099 workers and W-2 employees
2. General characteristics that apply to each type
3. Pros and cons of hiring
4. Employers’ payroll and tax obligations for 1099 workers and W-2 employees
5. How Heartland’s solutions can help - our Payroll and HR solutions partner of choice

Let’s start at the beginning. First, we’ll explore the naming conventions we’ll use in this blog: a 1099 worker versus a W-2 employee.

Understanding the 1099 vs. W-2 Terminology: Where Do These Terms Come From?

Before we dive into the nitty gritty, let’s cover some terminology.

1099 workers are also known as independent contractors, contractors or freelancers. Throughout this post, we may use these terms interchangeably. But we’ll mostly use “1099 worker” to refer to any worker you don’t hire as an employee or pay a regular wage. Why? Because we’re going to get into some tax stuff. And the 1099 form is what you will use to report payments you’ve made to every contractor you hire.

Conversely, we’ll use “W-2” to describe workers that you hire and pay as part of a traditional, part- or full-time employment relationship. They’re commonly and simply called employees. And you’ll likely recognize the W-2 tax form because you distribute them every year.

Using tax forms to highlight the differences between workers may imply that the Internal Revenue Service (IRS) alone determines who’s who. And while they have their own criteria on what qualifies people as either a 1099 worker or W-2 employee, they aren’t the only agency to weigh in. The Department of Labor’s Wage and Hour Division (WHD) has their own standards. And both agencies have agreed to work together to improve and enforce compliance for properly classifying workers.

That’s because bona fide employees are eligible for certain protections under the Federal Labor Standards Act (FLSA) as well. Under the rule, nonexempt employees are entitled to minimum wage and overtime pay for any hours worked in excess of 40 in a workweek. That’s why getting it right is so important. Misclassified workers could land you in violation of labor laws and subject to noncompliance fines or litigation, in addition to IRS penalties.

In the next section, we’ll dive into the details from both agencies and explore the differences between workers through a federal lens. But it’s also important to check if your state or municipality — and each one your business operates in — has laws or guidance on worker classification.

Key Differences Between 1099 Independent Contractors and W-2 Employees

Between the WHD and the IRS, information abounds when it comes to determining who is a 1099 worker versus a W-2 employee. But both agencies’ standards are built around one central idea: degree of control. The more control business owners have over when, where and how workers do their job, the more likely those workers are considered a W-2 employee under the law. On the other hand, if you define the scope of a project, but do not direct or control how or when the project is completed, you are likely dealing with a 1099 worker.

But that’s not all. Let’s take a look at some additional characteristics that differentiate the two.

Generally, 1099 workers are:

1. Hired via bid or written contract to complete a specific project, and can be hired by other companies while they work for you
2. Self-employed and use their own equipment to complete work
3. Free to hire whomever they want or need to help
4. Financially invested in the project and stand to incur significant profit or loss based on its outcome
5. Engaged for a specific period of time and paid on a per-project basis

W-2 employees typically are:

1. Hired after filling out job applications and going through a traditional interviewing process
2. Employed by you, and use your tools and equipment to complete their work
3. Not free to hire others to assist them with their job
4. Reimbursed for any business expenses they incur related to projects or their work
5. Guaranteed and paid a regular wage — or commission — on an hourly, weekly or other ongoing, semi-regular basis

While those lists hit the high notes, they’re not all-inclusive. They’re not prescriptive, either. Every employment situation is unique and no one characteristic establishes a worker’s status.

Weighing the Pros and Cons: Should You Hire 1099 Contractors or W-2 Employees?

Is it better to hire 1099 workers or W-2 employees? To answer that question, you’ll have to think about what’s most important to you. Because both types of workers bring specific types of strategic advantages to the table. For example, hiring a 1099 worker can help you keep your costs in check overall. But, hiring an employee ensures you get the results you want, when and how you want them. Let’s take a look at some other advantages and disadvantages each type of worker provides:

Pros and cons of hiring 1099 workers

Let’s start with the good stuff. Hiring 1099 workers can give you a leg up in a few ways, because they:

1. Tend to cost less over the long run: We touched on this above, but here’s a little more detail as to why it’s often true, even though it seems like you pay contractors more. Since 1099 workers aren’t employees, you don’t have to pay them a salary, overtime, or remit your share of Social Security, Medicare and unemployment insurance taxes. You don’t have to offer them employee-type benefits, including workers’ compensation insurance or health insurance. And they don’t factor into your full-time equivalent employee (FTE) calculation, which could free you from certain employer compliance requirements under the Affordable Care Act (ACA).
2. Give you more flexibility: Ultimately, hiring 1099 workers gives you the help you need, when you need it, with none of the hiring hassle. Once the job, project or task is done, you and a 1099 worker simply shake hands and walk away — no messy or formal termination process required.

Pose less of a legal risk: Earlier, we mentioned that W-2 employees are entitled to certain protections under the FLSA. As a result, employees who aren’t paid in accordance with those laws can pursue legal action against their employers. Employers who are found in violation can be liable for back wages, liquidated damages and penalties. Because 1099 workers aren’t employees, you don’t have to worry about following the letter of wage-and-hour law or suffering financial consequences for noncompliance.

Naturally, hiring a 1099 worker isn’t all sunshine and roses. There are some downsides too. Before you rush into an agreement with an independent contractor, ask yourself if you’re willing to deal with:

1. No control over the work: While you certainly have a say on whether the result of a task or project is up to snuff, you can’t control how 1099 workers achieve that result in any way. You also can’t make demands on when those workers or their teams spend time on your project, or where they do it. That means once you sign a contract with a 1099 worker, you are married to their methods and schedule, whether you like it or not.
2. Restrictions around firing: Depending on the type of agreement you make with a contractor, you may not have the freedom to fire them whenever you deem it necessary. Unlike employees who can be terminated, 1099 workers often negotiate the length of their engagement up front. Firing them early could result in a breach of contract and expose you to all of the legal pains that come with it.
3. Spotty results: As is life, hiring 1099 workers is like a box of chocolates: You never know what you’re going to get. Even if you’re engaging contractors through legitimate websites or based on solid recommendations from people you trust, there’s always going to be an element of uncertainty. This, combined with the lack of control and inability to fire them, could stick you with someone who doesn’t get the job done well. If you plan to rely mostly on 1099 workers, you could end up paying for inconsistent performance a lot.

Pros and cons of hiring W-2 employees

The easiest way to understand the advantages and disadvantages of hiring W-2 employees is to think of the above section from the opposite perspective.

For example, hiring employees may cost you more over the long run, but you control the work they do, and when and how they do it. You can train them to complete tasks and projects the best way possible, and hold them accountable for the quality of their work.

Not only will you have more control over the work, you’ll have it over your team too. While it’s true that going the 1099 route allows you to hire only when you need help and keep your labor costs under control, flexibility will probably end there. Expanding your project’s scope, changing your goal or firing your contractor would require renegotiation. On the other hand, employees are easier to motivate when the project or task requires more time or effort than you originally planned. They’ll go the extra mile when the going gets tough. All you have to do is ask.

Lastly, hiring 1099 workers may free you from certain compliance requirements or minimize your legal risk. But it doesn’t mean you’re completely out of the woods. Because contractors aren’t covered by workers’ compensation benefits, if they are injured on the job, they can sue you and your business for damages.

When you’re deciding whether to hire 1099 workers or W-2 employees, take all of these factors into consideration. Weigh them carefully against the goals of your project and how you want to direct it. Once you’ve chosen the arrangement that best fits your needs, ensure you’re crossing your t’s and dotting your i’s when it comes to managing payroll and taxes for each type.

Tax and Compliance Considerations: Properly Reporting and Managing 1099 vs. W-2 Workers

One of the biggest differences between 1099 workers and W-2 employees is your responsibility as an employer when it comes to payroll, taxes and reporting to the IRS.

Consider these tax tips if you hire 1099 workers

Contractors manage their own payroll tax withholdings and income tax reporting. But as someone who hires a 1099 worker, you’re not off the hook completely. Business owners still have a few things to do, like:

1. Ask them to send you a W-9 form before they start work. You’ll need the information on this form to complete other tax documents later on. You don’t have to submit this form to the IRS, but recordkeeping requirements dictate you keep it on file for four years.
2. Request invoices. Asking to be charged for something may sound crazy, but helping your contractors keep up with billing will make your life much easier at tax time. Because the amount you pay 1099 workers determines which form you submit to the IRS, managing a running tally will prevent any last-minute scrambling.
3. File form 1099-NEC. This is where having a running knowledge of the amount you’ve remitted to individual contractors comes in. If you’ve paid a 1099 worker more than $600 for services provided during the year, you need to complete the 1099-NEC. Then, provide a copy of the 1099-NEC to the contractor by January 31 of the year following payment, and a copy to the IRS.

Certain types of payments may also require you to complete and submit form 1099-MISC. Check out IRS guidance for details.

Complete these tasks for W-2 employees

As a business owner, chances are you’re pretty familiar with this to-do list. But we’ll leave it here just in case. For W-2 employees, it’s important to:

1. Distribute and collect W-4s: All newly hired, full- and part-time employees should receive, complete and submit a W-4 to you. Unlike 1099 workers who are responsible for calculating their own share of certain taxes, W-2 employees rely on you to do so. The W-4 form gives you the information you need to properly calculate withholdings — like Social Security or Medicare taxes — so you can accurately deduct them from payroll and remit them on employees’ behalf.
2. Ensure employees complete and turn in I-9 forms: While the I-9 isn’t a tax form, it is an important step in hiring and onboarding W-2 employees. The I-9 determines whether employees are eligible to work in the US and it requires a fast turnaround. In addition to employees filling out the appropriate fields, employers must complete and sign Section 2 within three business days of the hire date. You don’t have to file this form, but are required to keep it for three years.
3. Provide and file W-2 forms: It’s crucial that as an employer, you complete and file — electronically or by mail — with the Social Security Administration (SSA). You also need to furnish W-2s that show the wages paid and taxes withheld for the year to each employee.

Keep in mind that this list isn’t comprehensive. Based on state or local laws, you may need to check a few more boxes or fill out a couple more forms. When it comes to covering all of your bases, consulting an expert is probably your best bet.

Leveraging technology to make it all hassle-free isn’t a bad idea either.

You don’t have to go it alone

Often, the administrative work of hiring employees and managing payroll can take you away from the important work that really drives your small business forward. And keeping up with legal changes that can affect how you manage or pay your teams? Forget about it.

That’s why in this day and age, navigating it all with the right partner is key. Heartland’s Payroll+ solution makes guesswork a thing of the past. It automatically calculates how much employees should be paid each pay period by considering hourly rates and salaries as well as overtime.

You can also rely on the system to calculate, file and pay your payroll taxes to the appropriate agencies, saving you time and helping reduce the risk of penalties for late payments. Federal, state and local payroll taxes are automatically and accurately submitted. We’ll issue and file your W-2 and 1099, plus provide electronic copies for employees.

Lastly, Heartland’s HR solution makes complying with recordkeeping and other labor law requirements a breeze. Because their system is cloud-based, all employee and payroll records are automatically saved and secured. And their team will alert you to legal changes that could change how you manage payroll or your employees.

Best of all? It’s backed by an on-demand team of payroll and HR experts. Get one-on-one advice and support from certified professionals when you need to understand labor law, have a question about policy or want a different perspective.

Here’s the bottom line: Your goals and the work it takes to make them a reality are too important to leave to chance or a knee-jerk decision. The next time you need to hire, take a moment to consider the differences between 1099 workers and W-2 employees. Then, choose the best fit.

Tough Leaf has partnered with Heartland to bring certified small, local, and diverse firms access to flexible and easy-to-use payroll solutions.