W-2 vs 1099 Workers: The Ultimate Hiring Guide

Hiring new employees is a critical indicator that your business is thriving. However, the downside is that it involves a lot of paperwork—a seemingly endless stream of documents to verify which type of employee you are hiring. W-2 vs 1099.

At first glance, it might sound like a teeny-tiny difference. Yet, confusing these two classifications can result in expensive legal and business challenges. 

These include penalties, back pay, government investigations, and sometimes even jail time.

Therefore, it is important to understand and maintain the distinction between a W-2 employee and a 1099 contractor. 

Unfortunately, hiring compliantly in the USA can be tricky due to the stringent federal laws. 

To make matters even more complex, state-specific regulations also need to be followed. 

But don’t worry, we have got you covered. In this article, we will provide everything you need to know about the W-2 vs 1099 distinction, the different tax obligations, and how you can avoid the risk of employee misclassification.

What is a W-2 Employee?

In the simplest of terms, a W-2 employee is an individual formally employed by a company or organization in the United States. 

Under the Fair Labor Standards Act (FLSA), these individuals are entitled to specific benefits and protections, such as minimum wage, overtime pay, and unemployment benefits. 

Tax Obligations for W-2 Employees

As set forth by the IRS, three main tax obligations must be fulfilled by any employer who hires a W-2 employee in the USA. They include the following. 

• Federal Income Tax: Employers must withhold federal income tax from the employee’s wages.‍
• Social Security and Medicare Taxes: Employers must deduct Social Security and Medicare taxes from the employee's wages and pay the employer's share of the taxes. 
• ‍Additional Medicare Tax: Employers must also withhold 0.9% of the additional Medicare tax on employees' wages or compensation, which is more than $200,000 annually. Currently, there is no employer match for this tax.

What is a 1099 Worker?

A 1099 worker is someone who works as an independent contractor instead of an employee. 

These individuals are commonly referred to as freelancers, gig workers, or self-employed workers. 

The 1099-MISC is the primary tax form that reports payments made to independent contractors. 

Tax Obligations for 1099 Workers

Unlike a W-2 employee, a 1099 contractor needs to file their own annual income tax return and pay estimated taxes quarterly. 

Additionally, they are also required to pay self-employment (SE) tax, which shares some similarities with social security and Medicare taxes. 

To determine if a 1099 contractor is subject to SE tax and income tax, they first need to estimate their business's net profit or net loss by subtracting business expenses from business income.

Key Differences Between W-2 and 1099 Workers

Below, we have created a detailed list that outlines the major differences between 1099 and W2 workers based on different parameters, such as job duties, employee benefits, and more. 

Let’s take a closer look. 

1. Control and Autonomy

In general, if an employer can control what tasks need to be done and how the worker can do them, then that individual is considered a W-2 employee. 

However, a 1099 worker is not usually bound by such strict obligations. 

They have the freedom to decide when and where to perform the work, which tools and equipment to use, and what order or sequence to follow when completing the task.

2. Job Duties

When it comes to performing job duties, a 1099 worker usually enjoys much more autonomy than a W-2 employee. 

They have the flexibility to decide how many hours they are willing to spend on the task, can hire and pay additional assistants to help with the work, and can use their own choice of tools and materials to complete the work.

A W-2 employee, on the other hand, does not have such flexibility. 

Under the labor laws of the USA, all employees are required to work 40 hours per week. 

The work must be performed on the employer’s premises, and the employer has the right to assign additional projects to the worker. 

3. Cost Comparison

When hiring a W-2 employee in the United States, employers must manage various costs. 

These include payroll, tax contributions and payments, state unemployment compensation insurance, and worker’s compensation, among others. 

Additionally, non-exempt employees need to be provided with overtime pay, which is calculated at a minimum of 1.5 times the regular rate for each hour over 40.

However, hiring a 1099 contractor can avoid all these costs. 

You won’t need to pay for unused vacation or other expenses when they leave the job.

4. Payroll Taxes

In an employment relationship, the employee and the employer must pay social security tax (6.2%) on up to $168,600 of the earnings each. Additionally, a 1.45%  Medicare tax is also levied on all earnings.

A 1099 worker or independent contractor needs to pay the whole amount (employee and employer’s). 

This equates to 12.4% of social security tax, up to $168,600 of net earnings, and a 2.9% Medicare tax. 

If the income exceeds $200,000, then an additional 0.9% in Medicare taxes needs to be paid.

Most businesses use an automated contractor payroll management system to handle all these complexities. 

This system not only helps to reduce some of the burden but also facilitates compliance and accurate tax deductions.

5. Employee Benefits

As a W-2 employee, individuals in the USA are entitled to certain mandatory benefits, such as the following,

• Healthcare insurance benefits
• Leave benefits
• Disability insurance
• Unemployment insurance
• Worker’s compensation

However, since a 1099- worker is considered self-employed, they are not eligible for these statutory benefits.

6. Impact on Company Culture

When hiring a W-2 employee, you select the candidate you deem the best fit for your organization. 

These individuals become a part of your team and workplace, contributing to a better company culture. 

Additionally, when employees feel valued or secure in their roles, they are also likely to display increased focus since they no longer have to look for another job.

A 1099 contractor, on the other hand, is not always invested in the company culture. 

They complete the required task or assignment and move on to the next. This can sometimes be disruptive for other employees and the work culture.

Examples of W-2 vs. 1099 Worker

Below are some examples of which job roles fall under which category to help you better understand this distinction between W2 and 1099 workers.

Examples of W-2 Employees:

• Project managers who have ongoing work and standing team meetings.
• Delivery drivers working fixed hours and routes who use a company car or signage.
• Designers or developers with ongoing work and scheduled hours.

Examples of 1099 Contractors:

• Freelance content writers who work on an assignment basis instead of set hours.
• Consultants who service an organization for a project with a clear start and end date.
• Gig workers who perform services and receive monetary compensation through an app in return.

How to Decide Which Type of Worker to Hire

Now that you know the difference between W2 and 1099 workers, let’s examine some of the many scenarios that are best suited for hiring independent contractors or employees. 

When to Hire a W-2 Employee

• If the role that you are hiring for revolves around core business functions, such as salespeople, production staff, or customer service representatives.
• If you have ongoing, regular tasks that require a set schedule.
• If the work demands the utilization of the company’s equipment or protocols. 

When to Hire a 1099 Contractor

• When you need specialized skills or expertise for a specific task or project, once the assignment is complete, you can terminate the contractor agreement accordingly. 
• If you are a small business with a limited budget and cannot handle the financial burden of payroll taxes or employment benefits.
• If the nature of the task or assignment is such that it can be performed independently without oversight.

How to Hire W2 Employees

Here is a step-by-step guide on how to hire employees in the United States of America.

• Ensure you have an Employer Identification Number EIN: Before hiring a W-2 employee, you must register your business with the federal and state authorities. Under the IRS guidelines, every business with employees must have an EIN, which is a unique nine-digit number used for tax ID purposes.

• Create a clear job description: Once you have completed the legal work, you can start the hiring process. The first step is to draft a clear, concise, and detailed job description. 

• Source and interview potential candidates: You can publish the job description on various job platforms, such as LinkedIn, Indeed, or Craigslist. By conducting proper interviews, you can assess candidates' previous work history and experience to ensure their qualifications for the role. 

• Do a background check: Remember to conduct a thorough background check, which will include educational verification, previous employment verification, or a criminal record check, among other things.

• Onboard and add them to your payroll: Once you have completed all these steps, you can begin the onboarding process, which includes training, providing necessary tools, and adding them to the existing payroll system. 

If all these seem too much to handle, you can always seek out the services of an EOR (Employer-of-record), such as Skuad, with expertise in 160+ countries. 

Skuad facilitates the entire international hiring process by reducing the risk of employee misclassification and featuring numerous capabilities, such as digital onboarding, payroll in 100+ currencies, and more.

How to Hire 1099 Contractors

Moving on, here is a detailed outline of how to hire someone as an independent contractor.

• Validate if the worker is ‘1099 qualified’: As an employer, it is very important to ensure accurate classification of the workers. Therefore, before hiring a contractor, ensure they meet all the IRS requirements for 1099 independent contractor status.

• Check credentials and employment history: Carefully evaluating the worker’s previous work experience and qualifications will help you understand how well the person can contribute to the project.

• Draft a contract: Follow IRS guidelines to create a proper contract for freelancers. Additionally, establish clear expectations and requirements for the project/assignment for the independent contractor to follow.

• Have them fill out the necessary forms: Before the independent contractor starts their work, make sure they have signed the written contract and filled out other necessary documents, such as the W-9 form (tax document) and the 1099-MISC form.

• Integrate them into the company: As the last step of the contractor onboarding process, introduce the candidate to other team members of your company whom they can contact regarding any doubts about completing the project. 
  Communicate the company’s culture to them and provide other relevant information related to the task/assignment.

Legal and Financial Risks of Misclassification

Employee misclassification is extremely expensive, to say the least. If you get caught by the IRS, be prepared to face the following penalties,

• $50 for failure to file the W2 form
• 1.5% of wages, plus 20% of the Social Security and Medicare taxes (employee’s contribution), 100% of the matching tax for the employer’s contributions.
• Up to 25% of the total tax liability 

If the employee misclassification was intentional, the penalties increase further, resulting in 20% of the worker’s wage, 100% of the FICA taxes (both employer and employee contributions), and additional fines up to $500,000 with possible jail time.

IRS Guidelines for Classification

Previously, the IRS used a 20-factor test, the Right of Control test, to determine if a worker would be classified as an employee or an independent contractor. 

However, due to its complicated nature, it was later scrapped and replaced with three main categories. They are namely,

• Behavioral control: If the company controls or has the right to control what the worker does and how the worker performs the job.
• Financial Control: If the organization directs or controls the economic and business aspects of the worker’s job. 

This includes how the worker is paid, whether reimbursements are provided for any business expenses, and who provides the tools and equipment.

Relationship of the parties: If there is a written contract, the worker gets employee benefits such as paid leave, pension plan, or health insurance.

How to Correct Worker Misclassification

If you find yourself dealing with employee misclassification, the US government already has a voluntary program in place under the name Voluntary Classification Settlement Program.

It is specifically designed for businesses that wish to reclassify their workers as employees for future employment tax purposes. 

Under the program, eligible organizations will receive partial relief from federal employment taxes. 

In return, they will need to pay 10% of the employment taxes that would have been due for the misclassified individuals during the previous tax year.

How to Hire and Pay International Contractors

Let’s look at the various steps in hiring international contractors compliantly and efficiently.

• Research on the domestic and international regulations and tax rules to ensure compliance
• Decide which currency you will use for paying international contractors. Consider the worker’s considerations and the payment schedule.
• Choose a payment method such as International bank transfers, checks and international money orders, credit cards, or digital wallets.
• Create a proper agreement outlining the nature of your business relationship, fees, scope of work, and payment terms, among other relevant details.
• Collect all relevant documents, such as tax forms, contact information, and licenses, and onboard the contractor.

Hire Employees and Independent Contractors with Skuad

Whether hiring employees for your organization or independent contractors, Skuad EOR is an all-inclusive platform that facilitates every aspect of the international hiring journey.

With Skuad, you can always stay up-to-date with the latest labor and tax law changes. 

This means a reduced risk of non-compliance and a lesser chance of employee misclassification.

Additionally, with Skuad’s AOR solution - a leading contractor management software, you can seamlessly onboard new contractors, automate all invoicing and payments, protect your company’s IP under the relevant laws, and more.

‍Book a demo today and experience the Skuad advantage first-hand!

FAQs

1) Is it better to hire a 1099 or W2?

Ans: Truth be told, there is no right answer as to who you should hire between W2 vs 1099 workers. It all depends on your business needs. For example, hiring a 1099 contractor can be cheaper, quicker, and less of a regulatory burden. However, if the work that needs to be performed is related to your business's core activities, such as managerial tasks or marketing, then hiring a W-2 employee would be wise.

2) Do you pay more taxes on 1099 or W-2?

Ans: A W-2 employee in the USA is required to pay only 50% of the social security and Medicare taxes, which are automatically deducted from their paychecks by the employer. A 1099 contractor, on the other hand, is responsible for paying 100% of all the taxes themselves. 

3) What is the meaning of W-2?

Ans: W-2, also known as a Wage and Tax Statement, is a document the employer sends to the employee and the IRS. It primarily displays the income earned from an employer and the taxes withheld from the employee’s paycheck.

4) What are the cons of hiring a 1099 employee?

Ans: Some significant benefits of hiring a 1099 contractor include limited control over workers, lack of employee loyalty, lack of copyright ownership, and increased risk of liability issues.

5) Can I hire a 1099 contractor instead of a W-2 employee?

Ans: Yes, employers in the USA can hire a 1099 contractor as long as they are correctly classified and all the tax obligations, as laid out in the IRS guidelines, are fulfilled.