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August 10, 2022

W2 vs. 1099: What is the Difference?

Merrell Sheehan

Written by:

Merrell Sheehan

W2 vs. 1099: What is the Difference?

Do you know the difference between a 1099 and W-2? Could you articulate the differentiations in black and white terms? Not sure what worker is right for you? If not - we got you.    

Key Takeaways You Will Get From This Article

1. A 1099 is a tax form utilized by self-employed independent contractors which documents various forms of compensation paid from a business or individual that is not a direct employer. 

2. A W-2 is a tax form utilized by businesses to indicate the amount of income earned by a direct employee, the amount of taxes withheld, and outlines the benefits (if any) provided by the company.

3. The primary difference between a W-2 employee and 1099 worker is that a W-2 worker is on direct payroll and a 1099 worker is an independent worker who pays out their own taxes.

Electronic Merchant Systems offers payment method solutions, creating a simple and seamless payment experience for your valued customers. We empower companies with mobile processing, web commerce, and POS Solutions

We know that many workers and business owners alike don't fully understand the difference between a 1099 and W-2. The truth is: figuring out how to classify independent contractors vs employees can be difficult. 

It's essential to understand how workers are classified, even if you outsource payroll services to an accounting firm. Recruiters and hiring managers in particular need to understand the key differences in order to fill skill gaps and gain access to the right talent.  

The article below covers the definitions of 1099 and W-2 workers and their primary differences.  

Table of Contents:

 

What is a 1099 Worker?

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A 1099 is a tax form utilized by self-employed independent contractors which documents various forms of compensation paid from a business or individual that is not a direct employer. 

1099 workers go by differing sobriquets (contract workers, freelancers, etc.) and act as extra, highly-specialized support for a businesses. 

When you hire an independent contractor, generally, you contract them to carry out a niche role or complete a specific task (one that might not prove fiscally advantageous to hire, train, and retain a new employee to perform). 

1099 contractors tend to set their own hours and utilize their own tools and resources.

Independent contractors often work for more than one business - unless they have signed specific non-compete clauses that inhibit them from doing so.  

In short, independent contractors are self-employed, so you (aka, a business) don't withhold taxes from their paychecks.

These independent workers pay their own taxes and report their income via the IRS's 1099 form. As a business owner, you don't provide 1099 workers with employee benefits like your full-time employees.

Some common examples of 1099 workers are:

  • Freelancers

    Freelancers are self-employed individuals who choose the projects they want to work on and the rates they receive. Freelancers can be paid by the hour or per project and often work with more than one company at a time. 
  • Independent contractors

    Independent Contractors can choose their work and how they are paid. But independent contractors typically opt for long-term work arrangements with one or two clients. Most independent contractors are paid by the hour and sometimes opt for a retainer. 
  • Consultants

    Consultants are self-employed professionals with extensive skills, training, and knowledge in their fields. Their expertise and abilities command high compensation for their services.
  • Gig workers

    Gig workers perform temporary, flexible jobs through an online app or platform. Gig workers are usually paid for each task, not by the hour. 

  • Contractors

    Contractors are self-employed individuals that find work through a vendor or agency. A contract worker may report to a manager and receive regular payments through the agency.

 

Determining Who the Independent Contractors Are

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The primary difference between an employee and independent contractor is that businesses have less direct control over an independent contractor (but companies don't have to provide 1099s benefits, so it evens out). 

The IRS defines three categories to determine the degree of control or independence in your relationship with your employee:

  • Behavioral: Can the business control what the worker does and how they do their job?
  • Financial: Are the business aspects of the worker's job controlled by the payer?
  • Type of relationship: Are there written contracts or employee-type benefits? Is the relationship permanent or for a specific period of time? Is the work performed a vital aspect of the business?

Granted, there is no magic formula for the perfect accountability and independence balance. Generally, 1099 expectations are set in crystal clear terms, with deadlines proving the main accountability factor.  

Once you've decided whether the person is an employee or a contractor, document the factors that led you to that determination.

 

What is a W-2 Employee?

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A W-2 is a tax form utilized by businesses to indicate the amount of income earned by a direct employee, the amount of taxes withheld, and outlines the benefits (if any) provided by the company. W-2s can apply to part-time, seasonal, and full-time workers. 

Businesses hire a W-2 employee under an employment agreement.  

Unlike 1099s - business owners withhold federal and state income taxes, Social Security, and Medicare.  

W-2 employees are investments. The company invests in training W-2 workers, pays employment taxes for them, and often provides benefits. 

You have much more immediate influence over your W-2 workers than over your contractors. For example, you decide what W-2 employees work on, when they work on it, and how they interact with other employees.

 

When Do 1099s and W-2s Come Into Play?

1099s and W-2s are tax forms. A 1099-MISC reports payments made to independent contractors.

A W-2 form is used for employees.

 

Differences Between W-2 and 1099 Workers

Of course, the primary difference between a W-2 employee and 1099 worker is that a W-2 worker is on direct payroll and a 1099 worker is an independent worker (who pays out their own taxes). 

Obviously, the names "W-2 employee" and "1099 worker" come from their tax forms. Each tax season, employers file a Form W-2 to the IRS on behalf of their payroll staff.

Companies that pay freelancers and other 1099 workers must issue a Form 1099-MISC. Both forms display the amount of money earned from the company within the given year.

In short, both classifications enjoy a different, highly-nuanced relationship with the employer.

And although companies can define who can be their employee and who cannot, the government decides whether a worker can be defined as a 1099 contractor or not.

Here are just a few ways a W2 employee is different from a self-employed worker:

 

Taxes

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Companies must pay payroll taxes like Social Security, Medicare, and federal income tax withholdings for their employees.

Independent contractors are responsible for filing their individual income taxes, but they can make business expense deductions that employees cannot.

 

Legal Protections

W-2 workers enjoy various degrees of legal protection as established by local state and federal government (i.e. minimum wage laws, sick/leave time, overtime restrictions, and more). 

Unfortunately, these laws do not apply to independent contractors. Governments want as many people covered by these laws as possible as a matter of public policy.

In sharp contrast, contract law relies solely on parties negotiating for their best interests. This highly negotiated relationship provides flexibility for independent contractors and less risk for business owners.    

Social Benefits

The majority of Americans get their health care through work. Almost all employers are required by law to offer health care to their W-2 employees. 

The United States government is extremely interested in ensuring everyone has access to affordable health care and is semi-prepared for retirement.

Companies also offer employees an increasing range of optional benefits. Benefits like student loan payments, wellness programs, disability insurances, and financial planning assistance.

*Note - Independent contractors do not get these benefits.

 

Should I Hire a 1099 or a W-2 Worker?

So, it all comes down to the nitty gritty question: who should you hire. The truth is, there is no right or wrong answer. The type of labor you hire should reflect your business needs.  

An independent contractor might be the right fit if you have a temporary or short-term project. If you need permanent help during busy periods, a W-2 employee is a more appropriate choice.

You can hire a part-time accountant to help with your bookkeeping for a few hours each week.

Or, some businesses outsource their bookkeeping to an independent contractor specializing in accounting. No matter which type of worker is better suited to fit your unique needs, ensure you understand the IRS guidance. 

Remember, each state has its own set of rules and regulations, so be sure to classify your workers accurately.

Bonus: Once you find great employees, you want to ensure that you can retain them and that they are happy. Check out our article detailing what motivates employees.

 

EMS Can Help With Payment Processing

In this article, you learned the difference between W-2 and 1099 labor and dived into what makes them unique. 

If you feel like your business has the right employees or contractors in place, it's time to take a look at your payment processing.

EMS is a national payment processor that offers business owners streamlined credit card processing solutions - robust POS systems, mobile payment acceptance, gift/loyalty programs, and much more. 

Related EMS Blog Articles - 

Is your small business using slow, outdated payment methods?

Click on the link below to book a free consultation and begin the journey of optimizing your business payment methods -

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