When it comes to hiring new workers, business owners can choose between independent contractors and employees. Contractors have more independence in how they conduct their work but aren’t protected by labor laws, such as minimum wage. They also receive different tax forms (1099 vs W2) to report their earnings to the IRS because employers don’t withhold taxes from their pay.
Because of the differences in payroll tax treatment, misclassifying employees as contractors can lead to thousands of dollars in fees and penalties. We guide you through the differences, so you can decide as an employer which type is right for your business.
Summary of a 1099 Contractor vs W2 Employee
Type of Worker
Paid Hourly or Salary?
Do I Pay Payroll Taxes on Their Earnings?
Can I Fire Them Easily?
|Full Time or Part Time?|
Hourly or flat rate; never salary
Yes—just beware of contract stipulations and dates
Usually part time, on demand, or by project
Hourly or salary
Yes—at-will employment reigns and you can also fire for performance or behavior easily (if documented)
Usually a consistent full-time or part-time schedule
Last updated on 05/05/2020
1099 vs W2 Workers: The Differences
Many businesses make decisions about whether to hire full-time (or part-time) employees or independent contractors as their business expands. There are a number of reasons you might want to hire one over the other, but let’s first discuss the main differences between a W2 employee and a 1099 contractor.
1. Payroll Taxes
When you hire employees, you’re responsible for doing payroll which includes withholding payroll taxes from their paychecks in addition to paying taxes on their earnings out of your own business funds. Contrary to employees, when you hire independent contractors, you pay them their total earnings for the period. You don’t have to withhold taxes—nor does your business pay taxes for employing them.
To simplify, imagine you have an employee who earns $1,200 for the week. Since they’re an employee (not a contractor), the amount of their paycheck will be less than $1,200—you’ll have to subtract the total taxes you’re required to withhold to determine how much to pay them. If the employee were an independent contractor however, they would receive the total $1,200. Contractors are responsible for squaring up their tax bill with the IRS on their own.
Tax Form 1099 vs W2
Although employers manage payroll tax payments for their employees, employees are responsible for ensuring they don’t owe any additional taxes (or aren’t entitled to a refund due to overpayment). In this sense, both employees and contractors have at least some responsibility to settle any outstanding bills with tax agencies. Employers help facilitate this by issuing year-end tax forms (1099 and W2) that show the total amount each worker earned for the year.
Contractors receive Form 1099, which shows the worker’s name, Social Security number, address, and total earnings for the year. Employees receive Form W2; it shows the same basic information, in addition to total taxes and other deductions withheld.
2. Federal Labor Law Protection
W2 employees and 1099 contractors are also treated differently when it comes to federal labor law protections. US labor laws protect employees from being paid less than federal minimum wage, currently $7.25 an hour, ensure that eligible employees (typically hourly workers) receive overtime for hours worked over 40 in a week, and set strict standards for when minors can work and the type of work they’re allowed to perform.
If any HR or payroll compliance rules are broken, employers can be sued and/or face litigation. Contractors however, aren’t privy to these protections and don’t have any recourse unless it’s explicitly stated in their contract.
Firing Employees vs Independent Contractors: At-Will Employment
Another factor to keep in mind is the At-will Employment doctrine; it gives you the right to terminate employees at any time without notice or cause (as long as it doesn’t violate any federal laws). If you need to fire a contractor, it may not be as easy; you’ll have to abide by the terms of the contract you signed at the beginning of your relationship with them.
- With a W2 employee, you can terminate employment at any time. To protect yourself, it’s best to include the at-will employment language in all employment agreements and employee handbooks. That said, you need to comply with all federal and state labor laws, which are meant to provide boundaries for employee dismissal.
- With a 1099, you need to pay attention to the terms of the contract you are signing and your right to terminate it. Some contracts are hard to break, so keep this in mind when negotiating. We recommend at least a 5-10 day notice of termination from either party.
3. Paychecks & Benefits
Finally, the last major notable difference between employees and contractors is the way in which they are paid and benefits they’re entitled to.
- W2 employees may be either salaried or hourly and either full time or part time with a consistent schedule (generally biweekly, semimonthly, or weekly).
- 1099 contractors aren’t as likely to receive consistent pay; although, you can pay them via monthly invoices or on a per project basis.
- Benefits like health insurance, flexible spending accounts, and so forth are reserved for employees.
Keep in mind that there are other differences between employees and contractors, but those are the top three you should know about before you decide on which kind of worker to hire.
Independent Contractors vs Employees: 1099 or W2?
According to the IRS, there are three main questions to ask yourself about classifying 1099 vs W2 team members at your business. Note that in general, only ONE of the questions has to fit the bill for a worker to be considered an employee.
- Behavioral question: Does the company control or have the right to control what the worker does and how the worker does his or her job?
If the answer is “yes,” the worker is likely a W2 employee. If the worker is free to manage their own schedule and work process, they are more likely a 1099 contractor.
- Financial question: Are the business aspects of the worker’s job controlled by the employer? (These include things like how a worker is paid, whether expenses are reimbursed, and who provides tools/supplies.)
If the company controls how the worker is paid and pays for expenses and supplies, they’re likely a W2 employee. If the worker has to send an invoice to get paid and/or cover their own expenses, they are more likely a 1099 contractor.
- Type of relationship question: Are there written employment contracts (vs projects or an independent contractor agreement) or employee-type benefits (like health insurance, vacation pay)? Will the working relationship continue for the foreseeable future if the work is done correctly, and is the work performed a key aspect of the business?
If the company provides employee benefits and believes the worker is there for the long term, they are likely a W2 employee.
1099 Advantages for Employers
Some business owners like hiring 1099 contractors, because of certain advantages over W2 employees.
- Lower tax bill: When hiring employees, you not only have to withhold their taxes but your company also has to pay Social Security, Medicare, and unemployment taxes. This is over and above what the employee pays. Independent contractors pay all of their own taxes.
- Lower hiring costs: Most states require you to buy workers’ compensation insurance for employees. This is not required when working with independent contractors.
- Lower benefit costs: Many full-time employees expect benefits such as healthcare, 401(k) plans, and paid time off. Independent contractors will not expect benefits.
- Decreases risk of being sued: You are not subject to the same federal labor laws with independent contractors as you are with employees. You’ll just need to watch what you put in their contract and be sure to include an “out” clause.
- Little to no training costs: Many contractors bring an expertise in their field, like technical recruiting or computer development in a specific language. This can save you time on training your current employees to learn additional skills.
- More flexibility: Pending your agreement with the independent contractor, you can generally use them as an on-demand resource and “dip in and out” as your business requires.
1099 Disadvantages for Employers
There are disadvantages to having a 1099 contractor on staff that employers should take note of when hiring.
- Higher hourly rate: In general, a contractor will charge more by the hour than a salaried team member would; after all, they have to pay taxes out of the money you pay them. However, you can explore contractors from other countries and consider newbies looking to prove themselves via freelance websites (like Upwork) and potentially save money.
- Teamwork: Since a contractor is an outsider, they may not be the best fit for your team the way an in-house employee would. You’ll want to make sure they understand company structure and their place in it early, as well as create a communication plan with them (for instance, scheduling weekly calls or updates).
- Capacity: If an emergency comes up, your contractor isn’t going to necessarily work late or burn the midnight oil, especially if they have other clients. An employee will usually work, within reason, to get the job done, even if that leads to overtime.
Let’s now talk about the flip side—why you might want an employee over a contractor to work for your business.
W2 Advantages for Employers
There are five major perks to posting a job and hiring a W2 employee for it:
- Recruiting: For recruiting purposes, you’ll get a lot more applicants, and a wider talent pool will be interested in the role. It’s also a lot easier to post the more permanent position on a traditional job board, like Zip Recruiter, than it would be for a contract role.
- Succession planning: As your business grows, you’ll need to promote people and have managers. Hiring W2 employees allows for this in a more consistent way, and it lets you have people “on deck” or able to help if someone unexpectedly resigns or needs to be fired. A contractor can’t typically help in those situations.
- Accountability: An employee will know that their employment, and potentially benefits, are on the line with their performance. They are typically more accountable than a contractor. Keep in mind though that there are great contractors out there, as well as unreliable employees.
- Company culture: In general, employees contribute to a more cohesive company culture. They may become great work friends and long-term employees. It is harder for contractors to do this, especially since they are typically off-site and don’t usually work consistent hours.
On the other hand, as we’ve touched on before, there are also some downsides to W2 employees.
W2 Employee Disadvantages for Employers
The top three disadvantages of hiring W2 employees are:
- Taxes and insurance costs: You have to pay payroll, unemployment, and workers’ compensation for all employees. That can add up quickly and should be considered when you add up the employee’s total cost to the company.
- Higher risk of litigation: You need to make sure you are implementing things like performance reviews and progressive discipline for behavior issues in order to make sure that you’re airtight in firing someone. Although most states are at-will, it’s much easier for an employee to find grounds to sue than it is for a contractor.
- Requires more time to manage: A W2 employee needs to be trained, will have questions, and needs to be transitioned into their role. They can take 30, 60, 90 days or even a full year before they are completely trained. These workers are a part of your team, which means you will invest much more time and money into helping them be their best than you would a contractor.
Both employees and independent contractors can be valuable assets to a business as they perform work you need to run the company. It’s important to understand the differences between the two and assess your needs. If you need a strong sense of control over the work and/or the worker’s time, you’re better off hiring an employee. Avoid falling into the trap of calling an employee a contractor, because that can come back to haunt you; taxes add up quickly, especially if you have to add fines and penalties.