1099 vs. W-2: 5 Key Differences, Examples, and Pros/Cons for Employers

What is a W-2 employee?

A W-2 employee is a worker whose employer deducts taxes from their paycheck and submits this information to the IRS using a W-2 form. These employees are typically considered full-time or part-time staff, and they receive various benefits such as health insurance, retirement plans, and paid time off.

W-2 employees are subject to payroll taxes, including Social Security and Medicare, which are partially paid by the employer. They are also eligible for worker protections under federal and state labor laws, such as minimum wage, overtime pay, and unemployment insurance. 

An important part of the definition of W-2 workers is that the employer has significant control over the work performed by the employee, including how, when, and where the work is done.

What is a 1099 worker?

A 1099 worker, also known as an independent contractor, is a self-employed individual who provides services to a company under a contract. Unlike W-2 employees, 1099 workers are responsible for paying their own taxes, including income tax, Social Security, and Medicare. They receive a 1099 form from each client they work for, which reports their earnings for the year.

Independent contractors have more control over how they complete their work, including setting their own schedules and using their own tools and resources. They typically do not receive employee benefits such as health insurance or retirement plans. 

Crucially, 1099 workers are not covered by most labor laws that protect employees, meaning they are not entitled to minimum wage, overtime pay, or unemployment benefits.

This article is part of our guide on 1099 employees.

Why is it important for employers to correctly classify workers?

Correctly classifying workers as either W-2 employees or 1099 independent contractors is necessary for several reasons. Misclassification can result in severe legal, financial, and operational consequences for employers.

1. Legal Compliance and Avoiding Penalties

Misclassifying an employee as an independent contractor can lead to penalties, back taxes, and interest. The IRS imposes fines on employers who fail to withhold and pay payroll taxes. State labor departments may also impose additional penalties for non-compliance with unemployment insurance and workers’ compensation requirements.

2. Financial Consequences

Misclassification can result in significant financial liabilities. Employers may be required to pay back wages, overtime, and benefits that were not provided to misclassified workers. Additionally, they may face lawsuits from workers seeking compensation for lost wages and benefits, leading to costly legal battles and settlements.

3. Impact on Employee Benefits and Protections

W-2 employees are entitled to various benefits and protections, such as health insurance, retirement plans, minimum wage, and overtime pay. Misclassified workers miss out on these benefits and protections, which raises ethical and social responsibility issues for companies.

Correct classification promotes fairness and equity in the workplace. It ensures that all workers are treated according to their employment status and receive the benefits and protections they are entitled to. This fosters a positive work environment and also helps attract and retain top talent.

5. Reputation and Trust

Businesses that consistently misclassify workers may suffer reputational damage. Negative publicity and legal disputes can erode trust among employees, clients, and stakeholders. Maintaining proper classification practices demonstrates a commitment to ethical business operations and compliance with labor laws.

What’s the difference between a W-2 worker and 1099?

The primary distinction between W-2 and 1099 lies in their employment status and their respective tax forms. 

#1 Legal employment procedure

• A W-2 individual is a formal employee who is included in the company’s payroll and receives a W-2 tax form annually, detailing wages earned and taxes withheld. 
• On the other hand, a 1099 worker is typically an independent contractor, freelancer, or other non-payroll professional, who receives a 1099 form which records the payment made to them by a client but lacks deductions for taxes. Thus, W-2 and 1099 serve as identifiers of these two distinct employment categories based on their different tax documentation requirements.

#2 Primary tax form

• Every tax season, employers file a Form W-2 to the IRS on behalf of their payroll staff. 
• Companies that pay contractors and contractors must issue a Form 1099-MISC to non-payroll workers. 

#3 Withholding Taxes

Companies pay payroll taxes for each employee. Payroll taxes include Social Security, Medicare, and federal income tax withholdings. When a company hires an independent contractor, it doesn’t pay these taxes. 

The independent contractors are responsible for filing their individual income taxes, but they can make business expense deductions that employees cannot. This currently means tax authorities are losing potential revenues as companies rely more on freelancers.

#4 Legal Protections for Employees

Local, state, and the federal governments all pass legislation providing worker protections. This includes minimum wage laws, required sick and leave time, and overtime restrictions. None of these laws apply to independent contractors. 

Governments want as many people covered by these laws as possible as a matter of public policy. In contrast, contract law relies on the parties to negotiate for their interests. A negotiated relationship provides greater flexibility for the independent contractor, but also greater risk.

#5 Social Benefits

Most Americans get their healthcare through work. Nearly all employers are required to offer healthcare to employees. Many contribute to employee retirement funds above compensation. Governments assert a public policy interest in ensuring everyone has health insurance and is preparing for retirement.

As companies compete for global talent, they also offer employees an increasing range of optional benefits. Benefits like student loan payments, wellness programs, and financial planning assistance. These benefits aren’t offered to independent contractors. The concern is that they are providing the same services to companies as employees, but on inferior terms.

Examples of W-2 employees

Full-time employees: These workers are typically hired for indefinite periods and work a standard number of hours each week, usually 40 hours. They receive a full range of benefits, including health insurance, retirement plans, paid time off, and other perks provided by the employer. Full-time employees are considered an integral part of the company’s workforce and contribute to its long-term goals and projects.

Part-time employees: Part-time workers usually work fewer hours than full-time employees, often less than 30 hours per week. They might receive some benefits, although typically less extensive than those offered to full-time employees. Part-time employees are used to meet specific operational needs, such as covering peak hours or handling seasonal workloads.

Temporary employees: Also known as temps, these workers are hired for a specific period or project. Temporary employees can work full-time or part-time, but their employment duration is limited. They are often sourced through staffing agencies and might not receive the same benefits as regular employees, though they are still subject to payroll tax withholdings.

Government employees: These are workers employed by federal, state, or local government agencies. They typically enjoy strong job security and comprehensive benefits packages, including pensions, healthcare, and paid leave. Government employees are protected under various civil service laws and regulations that ensure fair treatment and job stability.

Unionized workers: Union members work under collective bargaining agreements that dictate their wages, working conditions, and benefits. These employees often have additional protections and benefits negotiated by their unions, such as higher pay rates, guaranteed raises, and enhanced job security.

Implications for workers

W-2 employees benefit from the security and stability of regular income, structured work hours, and a comprehensive benefits package. This stability allows them to plan for the future, access healthcare, and save for retirement. They also benefit from legal protections, such as minimum wage laws, overtime pay, and unemployment insurance, which offer additional security and support.

Implications for employers

Employing W-2 workers means higher costs for employers due to payroll taxes, benefits, and compliance with labor laws. However, it allows for greater control over the workforce, ensuring that employees adhere to company standards and policies. This control can lead to higher productivity, better team cohesion, and alignment with the company’s long-term goals. Additionally, offering benefits and a stable work environment can help attract and retain top talent, fostering a loyal and dedicated workforce.

Examples of 1099 Workers

Freelancer: These are self-employed individuals who can pick and choose which projects they want to work on, as well as their rates. Most freelancers are paid by the hour or per project. Many freelancers work with more than one company at a time. 

Independent contractor: Like freelancers, independent contractors can choose their work and how they are paid. However, it’s more common that they opt for longer-term work arrangements with one or two clients. In this case, most independent contractors are paid by the hour. Sometimes they opt for a retainer. 

Consultants: These are self-employed professionals who have extensive skills, training, and knowledge in their respective fields. Due to the expertise and skills required to be a consultant, they often command high compensation for their services.

Gig worker: This is someone who performs temporary, flexible jobs, often through an online app or platform. Gig workers are usually paid for each task, not by the hour. 

Contractor: A self-employed individual who finds work through a vendor or agency. Depending on the company’s structure, workers may report to a manager and receive regular payments through the agency.

Implications for workers

As an independent business owner, 1099 workers assume the risk for their own profits or losses. Most often, they need to cover business expenses (such as equipment and ongoing professional development) themselves. They’re also responsible for filing their income to the IRS themselves, paying Self-Employment Taxes (which cover Social Security and Medicare), and paying income taxes. 

Implications for employers

If you hire 1099 workers, you don’t need to pay payroll taxes on their behalf. You also aren’t required to provide them standard employee benefits, such as PTO and sick leave, or contribute to their health insurance coverage or retirement plan. Overtime protections don’t apply to 1099 workers. 

Without all of these overhead costs, hiring 1099 workers costs about 30% less than W-2 employees. 

Pros and cons for employers: W-2 employees vs. 1099 workers

Pros of hiring W-2 employees:

• Stability and loyalty: W-2 employees provide more stability as they are typically hired for long-term roles. This fosters loyalty and allows the company to invest in their development.
• Control and supervision: Employers have greater control over W-2 employees, including their work schedules, processes, and outputs. This can lead to higher productivity and alignment with company goals.
• Team cohesion: As regular members of the workforce, W-2 employees contribute to team cohesion and a consistent corporate culture, enhancing collaboration and communication.
• Benefits and protections: W-2 employees receive various benefits such as health insurance, retirement plans, and paid time off, which can improve job satisfaction and retention.

Cons of hiring W-2 employees:

• Higher costs: Employing W-2 workers can be more expensive due to the cost of benefits, payroll taxes, and compliance with labor laws.
• Administrative burden: Managing payroll, benefits, and compliance for W-2 employees requires significant administrative effort and resources.
• Less flexibility: W-2 employees are typically less flexible compared to independent contractors, as they work set hours and follow company procedures.

Pros of hiring 1099 workers:

• Cost-effectiveness: Hiring 1099 workers can be more economical as employers are not required to provide benefits, pay payroll taxes, or offer other employee-related perks.
• Flexibility: Independent contractors offer greater flexibility, allowing employers to scale the workforce up or down based on project needs and business demands.
• Specialized skills: 1099 workers often bring specialized skills and expertise, making them suitable for specific projects or short-term assignments.
• Reduced administrative work: Employers have fewer administrative responsibilities when hiring independent contractors, as they do not manage payroll, benefits, or tax 

withholdings.

Cons of hiring 1099 workers:

• Less control: Employers have less control over how independent contractors complete their work, which can lead to inconsistencies in quality and delivery.
• Risk of misclassification: Misclassifying a worker as a 1099 contractor when they should be a W-2 employee can result in legal and financial penalties.
• Lack of team integration: 1099 workers may not integrate as well into the company culture, potentially affecting team cohesion and collaboration.
• Limited availability: Independent contractors may work for multiple clients simultaneously, leading to potential availability issues and divided attention.

How the IRS determines if a worker is a 1099 vs W-2

To help employers understand if an independent worker is truly self-employed, the IRS offers guiding questions that can help clarify the nature of the worker’s engagement with the paying company. The IRS calls the following the “common law rules,” which boil down to the degree of control the company has and the level of independence of the worker. 

1. Behavioral: Does the company control or have the right to control what the worker does as well as how the worker completes their assigned work?
2. Financial: Does the paying company determine the business aspects of the arrangement, such as how the worker is paid, who purchases tools and supplies, and whether expenses are reimbursed?
3. Type of Relationship: Have both parties signed written contracts or are there employee-type benefits (i.e. pension plan, insurance, paid time off, etc.)? Is the work relationship ongoing, and is the work performed a key aspect of the business?

Businesses that hire freelancers or other self-employed workers need to carefully consider all of these questions when determining whether they are indeed a 1099 worker. While some factors may indicate one classification, others may indicate another. 

The IRS recommends employers routinely evaluate the entire relationship, consider the degree or extent of the right to direct and control work, and also document each of the factors used to make the determination. 

Should employers hire W-2 employees or 1099 workers?

Each time a company identifies a need to hire someone, HR and executives should ask:

• Do I need this skill/talent “forever” or for a shorter-term, defined period of time? 
• How readily available is the needed talent? Is it possible to recruit a full-time employee, or should we quickly identify a qualified freelancer?
• How fast do we need to dive into work? Do we have time to onboard a new full-time staff member, or does it make more sense to jump in with a freelancer?
• How much does the talent cost? How do the salary and benefits of a full-time staff member compare to the hourly or project wages of an independent contractor or freelancer?

After understanding the difference between W-2 and 1099 workers in terms of costs, nature of work, availability, and expectations for speed, you will be in the right position to choose.

Fiverr Enterprise: Effortless Sourcing, Onboarding, and Compliance of 1099 Workers

Fiverr Enterprise is a SaaS solution that gives you full visibility and control over your entire freelance workforce by allowing you to source, hire, onboard, manage and pay, all while ensuring compliance, so your teams can work faster and maximize business growth. 

Fiverr Enterprise lets you work in a more agile way, sourcing and hiring freelance talent on the fly. You can simply post a job on the platform, and receive 2-6 fully-vetted freelancers in up to 72 hours or less. Pre-selected candidates are verified and available even quicker. 

With Fiverr Enterprise, by the time you have your first conversation, you already know the candidates are compliant, you already know they fit your budget, and you already know they are available to work. All that’s left to do is ask where they got that awesome Zoom background. 

Learn more about how Fiverr Enterprise can help you source, onboard, and handle the legal and tax compliance process for your freelance workforce.