We often hear people ask about the difference between W2 and 1099 workers. For recruiters and hiring managers in growing companies, understanding the difference is key to filling skills gaps and gaining access to the right talent.
This article is part of our guide on 1099 employees.
What’s the Difference between a W-2 worker and 1099?
The primary distinction between W2 and 1099 lies in their employment status and their respective tax forms. A W2 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, W2 and 1099 serve as identifiers of these two distinct employment categories based on their different tax documentation requirements.
Every tax season, employers file a Form W2 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. Both forms indicate the amount of money earned from the company within the given year. For W2 employees, it also includes employer-withheld taxes.
The differences between W2 and 1099 workers go beyond how they file taxes. In the eyes of the law and the tax authority, each type of employee has a different relationship with its employer. The more interesting fact that although companies can define who can be their employee and who cannot, it is up to the government to decide whether a worker can be define as a 1099 contractors or not.
The reason lies in the differences between the two definitions:
#1 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 for filing their individual income taxes, but they can make business expense deductions that employees cannot. This currently means tax authority are losing potential revenues as companies rely more on freelancers.
#2 Legal protections for employees
Local, state, and the federal governments all pass legislation providing worker protections. Minimum wage laws, required sick and leave time, overtime restrictions are but a few. 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.
#3 Social benefits
Most Americans get their health care through work. Nearly all employers are required to offer health care 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.
What is a 1099 worker?
1099 workers don’t have a single employer. Instead, they own their independent business. Within the broader category of 1099 workers, there are several types of self-employed workers, each with different nature of work. Here’s a brief breakdown of the most common ones:
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.
As an independent business owner, 1099 employees 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.
This means that 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 W2 employees.
What is a W2 employee?
Think of a W2 employee as the default worker classification. They are the typical, salaried workers that you hire to perform a specific role.
Unlike 1099 workers, W2 employees are hired for an indefinite period of time to perform consistently needed work. Of course, employees can resign after providing the required notice, and employers can terminate employees for poor performance or any other valid reason that doesn’t violate anti-discrimination laws.
While 1099 workers have the freedom to decide how they complete their assigned work, W2 employees do not. Companies can exercise complete control over the methods and schedules of their employees’ work. They must also provide all of the tools and training employees require to do their jobs, and reimburse employees for any approved expenses incurred on behalf of the company.
Employers are responsible for providing certain employee benefits, such as overtime protection, minimum wage, health insurance coverage, and paid time off. Many companies choose to offer even more benefits to win over in-demand talent, such as retirement plan contributions, extra time off, and services like child care, meal plans, and dry cleaning.
When it comes to paying taxes, companies simply withhold federal and state income tax, Social Security tax, and Medicare tax from employees’ pay. All of these amounts are included on the W2 form.
Examples of W2 Employees
- Retail employees
- Administrative staff
- Healthcare professionals
- Information technology professionals
- Office workers
How the IRS determines if a worker is a 1099 vs W2
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.
- 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?
- 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?
- 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 I hire W2 employees or 1099 workers?
By now, this question has probably crossed your mind. The answer isn’t always clear — it depends on your current business needs, strategy, talent needs, and priorities.
Both types of workers offer important value, and it’s possible to find top-tier candidates among full-time job seekers as well as self-employed individuals.
Each time you identify a need to hire someone, you 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 W2 and 1099 workers in terms of costs, nature of work, availability, and expectations for speed, you will be in the right position to choose.
Sometimes — like when you need to fill a key position that relates to your core business offering — hiring full-time workers is the way to go. But we’d be remiss not to mention that, more and more, companies are turning to freelancers and other 1099 workers to unlock the speed and agility they need to thrive in an increasingly competitive and unpredictable market.
The decision should be made on a case-by-case basis, and not with haste. By carefully considering the points we outlined above, you can expand your talent roster without stress.
Learn more about how Fiverr Enterprise can help you automate and customize the legal and tax compliance process for your freelance workforce.