1099 vs W-2 Workers: 5 Key Areas of Difference
This article is part of a larger series on Hiring.
Large and small businesses alike often find it most efficient to hire employees (W-2 workers) for some roles and tasks and independent contractors (1099 workers) for others. Understanding the differences between 1099 vs W-2 workers is important, as misclassifying employees as contractors can lead to thousands in fees and penalties.
1099 vs W-2 Quick Comparison
What Tax Forms am I Required to Use?
Paid Hourly or Salary?
Hourly or flat rate; never salary
Hourly or salary
Do I Pay Payroll Taxes on Their Earnings?
Can I Fire Them Easily?
Yes, just be aware of contract stipulations and dates
Yes, at-will employment reigns*, and you can also easily fire for performance or behavior (if documented)
Full- or Part time?
Usually part time, on-demand, or by project
Usually a consistent full-time or part-time schedule
*All states recognize at-will employment on a contractual level, except Montana.
As your business expands and you make decisions about whether to hire full-time (or part-time) employees or independent contractors, consider these five areas in which you will see differences.
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 business funds. When you hire independent contractors, you still have to run payroll; however, you pay them their total earnings for the period. Your business doesn’t have to withhold taxes.
Imagine you have an employee who earns $1,200 for the week. Since they’re not a contractor, the amount on their paycheck will be less than $1,200—because you’ll have to subtract the total taxes you’re required to withhold to determine how much to pay them. If they were an independent contractor, however, they would receive a total of $1,200. Contractors are responsible for squaring up their tax bills with the IRS on their own.
If you need help paying both contractors and employees, consider using a payroll software provider like Gusto. It can handle both your traditional W-2 employees and 1099 contractors (including international contractors)—all from its affordable platform.
2. Tax Forms
Although employers manage payroll tax payments for their employees, employees are still 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 W-2) that show the total amount each worker earned for the year.
- Form 1099-NEC: Contractors receive Form 1099-NEC, which shows the worker’s name, Social Security number, address, and total earnings for the year. Learn how to fill out and prepare this with our guide on the 1099-NEC form.
- Form W-2: Employees receive Form W-2, which shows basic information, in addition to total taxes and other deductions withheld. Learn how to fill out a W-2 form.
3. Federal Labor Law Protection
Employees and contractors are 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 and 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 contracts. Having an independent contractor agreement in place will help protect you.
4. Terminating Contractors vs Employees
Another factor to keep in mind is the at-will employment doctrine, which gives you the right to terminate employees at any time without notice or cause (as long as it doesn’t violate any federal laws). However, if you need to let a contractor go, 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 contractor, 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.
- On the other hand, 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.
5. Paychecks & Benefits
The last major notable difference between 1099 vs W-2 workers is how they are paid and the benefits to which they are entitled.
- Contractors aren’t as likely to receive consistent pay—you can pay them via monthly invoices or on a per-project basis.
- Employees may be either salaried or hourly and full-time or part-time with a consistent schedule (generally paid biweekly, semimonthly, or weekly). Benefits, like health insurance, flexible spending accounts, 401(k), and so forth are reserved for employees.
Questions to Ask When Classifying Workers
According to the IRS, there are three main questions to ask yourself when classifying 1099 vs W-2 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 their job? If the answer is “yes,” the worker is likely an employee. If the worker is free to manage their schedule and work process, then they are more likely a contractor.
- Financial question: Are the business aspects of the worker’s job controlled by the employer? (These include 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, then they’re likely an employee. However, if the worker has to send an invoice to get paid and/or cover their expenses, they are more likely a contractor.
- Working relationship question: Are there written employment contracts (versus projects or an independent contractor agreement) or employee-type benefits (like health insurance and 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 an employee.
Pros & Cons for 1099 vs W-2 Workers
Some business owners like hiring contractors because of certain advantages over employees. There are also drawbacks, however, to having a contractor on staff.
|Lower tax bill: Independent contractors pay all of their taxes. You only have to provide the contractor with a 1099-NEC. You do not have to collect taxes on their paychecks or submit payments to the IRS on their behalf.||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.|
|Lower hiring and benefit costs: Most states require you to buy workers’ compensation insurance for employees. This is not required when working with independent contractors. Independent contractors will not expect benefits such as healthcare, 401(k) plans, and paid time off.||Lack of 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 and create a communication plan with them (for instance, scheduling weekly calls or updates).|
|Decreased 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.||Decreased drive: 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.|
|Little to no training costs: Many contractors bring 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.||Higher turnover rate: A contractor has no stake in your business or a desire to help your business grow. They are typically there to make money for themselves. This can lead to high turnover, which will require you to go through the costly hiring process multiple times.|
There are some major perks to posting a job to find a great employee, including employee retention potential and accountability. On the other hand, as we’ve touched on before, there are also some downsides to hiring employees, such as increased tax and benefits costs.
|Recruiting: For a full-time W-2 role, you’ll get a lot more applicants as 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 ZipRecruiter, than it would be for a contract role.||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 determine the employee’s total cost to the company.|
|Succession planning: As your business grows, you’ll need to promote people and have managers. Hiring employees allows for this in a more consistent way and 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.||Higher risk of litigation: You need to make sure you are implementing things like performance reviews and progressive discipline for behavior issues 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.|
|Accountability: An employee will know that their employment, and potential 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, along with unreliable employees.||Requires more time to manage: An employee has 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.|
|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.||Cost of benefits: Typically, a company will offer healthcare benefits, retirement benefits like 401(k), and stock options. These come at an additional cost to employers.|
When it comes to hiring new workers, business owners can choose between independent contractors and employees (1099 vs W-2). Contractors have more independence in how they conduct their work but aren’t protected by labor laws such as minimum wage. Employees, on the other hand, provide more job stability for promoting and retaining employees.
Both W-2 and 1099 workers can be valuable assets to a business as they perform the work you need to run the company. 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 can add up quickly, especially if you have to add fines and penalties.