What is the difference between a 1099 contractor and a W-2 employee?

When it comes to 1099 contractors vs W-2 employees, one of the primary differences for businesses is in how you pay them. When W-2 employees are hired, they usually receive a benefits package, including a healthcare plan and options for disability, life insurance and retirement investments. Employers are responsible for withholding and remitting federal and state income taxes, Social Security, Medicare and unemployment taxes on behalf of employees.

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W-2 refers to the type of form an employee receives from your business at the end of the tax year with a summary of the wages, tips, earnings and tax withholding information for that tax year. The employee then refers to the W-2 when filing their taxes, using the numbers from the W-2 when asked for total income and withholding.

An independent contractor, on the other hand, is considered self-employed in the eyes of the IRS. They are usually engaged for short-term or per-project assignments, or may join client teams for longer-term engagements. Due to the contractual nature of independent contractors and clients, the contract may terminate at any time.

Independent contractor payments are based on an agreed upon hourly or flat-rate you negotiate in advance. And rather than you withholding taxes for the contractor, the contractor pays their own self-employment taxes. Businesses provide a year-end 1099-NEC form to their contractors, which includes a summary of all payments for the year.

1099 vs W-2 taxes

Classification of 1099 contractors vs. W-2 employees is where businesses need to approach with the most caution. It’s critical to determine whether you’re hiring an employee or engaging a contractor. There is a hefty cost to misclassifying your workers.

When a W-2 employee first starts working for you, they’ll receive a W-4 form to fill out for tax purposes. This tells your payroll operations how much tax to withhold and any other specifics around deductions and withholdings for that employee.

An independent contractor, however, must complete and return a W-9 tax form at the onset of engagement with you. The form requests identification and taxpayer ID from contractors in order for businesses to report income on behalf of the contractor. Additionally, most businesses also have some sort of contract or work agreement signed by both parties that delineates the terms of the agreement, such as scope of work, deliverables, deadlines and payment terms. It may also include legal agreements such as termination of contract and an NDA.

At the end of the tax year, employees will receive a W-2 form, as previously mentioned. Independent contractors receive a 1099-NEC, 1099-K or 1099-MISC form.

Business woman calculating annual tax on a calculator and using mobile phone.

Did you know?

The WorkMarket independent contractor management system automatically collects and verifies U.S. tax ID, W-9 and bank information from your independent contractors, accelerating the onboarding process so you can put people to work quickly.

1099 vs W-2: Which is right for your business?

The answer to this question depends on the needs of your business. If you have unpredictable customer demand and need a more agile workforce, then independent contractors might be right for you. For businesses that choose to engage 1099 contractors, there are many benefits including:

  • Greater flexibility to staff up or down depending on client demand

  • No costs associated with benefits like retirement, healthcare and paid vacation

  • Ability to tap into a growing pool of highly skilled professionals with reduced onboarding/training time

But if your business needs the stability of an in-house core team that can grow and work together, it may be best to stick with W-2 employees. Hiring employees allows you to:

  • Build an in-house knowledge base and ensure knowledge transfer

  • Establish and promote a preferred business culture

  • Work cross-functionally and across multiple departments in optimal ways

If the work is project-based, then there may be cost savings associated with engaging with a contractor vs. W-2 employee. Hiring W-2 employees generally carries the inherent cost of offering long-term salaries, health care, 401(k) and other benefits.

Both options have benefits and your best option will depend on the needs of your business.

The benefits of an independent contractor management system

If 1099 contractors are right for your business, you can leverage dedicated technology to automate the end to end process of managing these workers. Independent contractor management systems can streamline many of the manual processes associated with contractor onboarding/verification, talent organization, work assignment management and payment. At WorkMarket, compliance support is also built in, as we prep and file 1099-NEC forms with federal and state agencies, and ensure your independent contractors receive their copies.

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