The American workforce is changing dramatically. An increasing number of Americans are breaking ties with employers and going out on their own. This is causing employers and the workforce to make decisions between 1099 vs W2.
These individuals classify themselves as independent workers and are technically their own boss. They work under contract with another business and are commonly called 1099 workers.
This is a big difference from W2 workers that fall under a traditional business and employee relationship. In 2019, there were nearly 130 million full-time workers in the United States.
However, surveys show that 1 in 5 workers are independent contractors or freelancers. Over the next decade, this number is expected to rise to half of the workforce.
Read on to learn how to classify your employees. Explore 1099 vs W2 workers and the primary difference between the two.
What Are W2 and 1099 Forms?
To allow employees and contracted workers to pay income taxes, an annual wage report is required. The employer is legally required to submit wage reports to each person on their payroll.
W2 and 1099 Forms must be provided to employees and contracted employees by January 31st upon completion of the tax year. These reports are also filed with the Internal Revenue Service (IRS) and the Social Security Administration (SSA).
What Is a W2 Employee?
First, let’s start off with the traditional approach taken by most employers. A W2 Form is required for individuals that are considered official employees of a business. As such, the business is required to handle the employee’s many payroll deductions.
This includes federal and state income taxes, as well as county or municipal taxes that are withheld. For W2 workers, employers are also responsible for FICA deductions. FICA is the Federal Insurance Contributions Act and is the vehicle for funding government entitlement programs.
FICA deductions are made for Social Security and Medicare programs. These are benefit programs that you contribute to while working and enjoy during retirement. It is for this reason that your employer needs to file a W2 with the SSA.
As a W2 worker, you may be eligible for benefits such as health care or a retirement plan. The W2 also reports on contributions made to employer benefit plans.
What Is a 1099 Employee?
If a business pays more than $600 to an individual or business, they are required to file a Form 1099-MISC. The Form 1099-MISC covers business expenses like rent or services. It is also provided to attorneys, LLCs, or sole proprietorships.
Businesses frequently reach out to independent contractors or freelance workers for services. They do not require a full-time or permanent employee, so 1099 workers are the perfect solution. The best way to classify them is as non-employees who are working for a business on a non-permanent basis.
In the vast majority of cases, the deductions reported on a W2 are left blank on a 1099 Form. It is unusual for an employer to deduct income taxes, benefits, or FICA on a 1099-MISC.
Why Would an Employer Want to Hire a 1099 vs W2 Employees?
There are many benefits to the employer in hiring a 1099 worker in lieu of a permanent employee. For starters, they have more flexibility in letting a 1099 worker go. They do not have to pay into the state’s unemployment fund.
They also are not required to provide benefits. For example, laws like the Affordable Care Act require employers to provide health insurance to their employees.
Independent contractors and freelance employees fall outside the law. Therefore, the employer can save on indirect labor expenses by using 1099 workers.
How Does the IRS Classify 1099 vs W2 Employees?
There are some grey areas when trying to classify 1099 and W2 employees. Not every situation is as simple as an independent contractor with a business name.
For this reason, the IRS has provided guidance to help employers determine the proper classification. Continue reading for the three primary ways that the IRS evaluates this debate:
Behavioral Control
Behavioral control is the first factor that the IRS considers. For a W2 employee, the employer controls every aspect of their day-to-day job. They tell you what time to report to work and when you can leave.
Management says what method to use to complete a project. Also, the employer can reassign you to another project if necessary. Things are very different for a 1099 employee.
The only requirements set in stone are laid out in the contract. The contract is going to cover technical specifications and delivery schedules. Outside of that, independent contractors have control over operations.
So long as they meet the due date in the contract, they have more flexibility. For example, they are going to use their own methods and techniques to complete a project. Being your own boss is a reason that 1099 work is growing more popular in the United States.
Financial Control
As it pertains to payroll, W2 employees are at the mercy of the business they work for. The employer decides how frequently the individual is paid. They also have wide discretion over the pay rate.
This is not true for independent contractors. Like the project due date, the contract determines the payment schedule. Some contractors are paid at project completion, while others are given progress payments.
Relationship Type
Of the 3 evaluation criteria, relationship type is the most subjective. There are some common questions the IRS will ask to determine the relationship type.
Is the employee a critical part of the business? Do they receive benefits like health insurance or a dental plan?
Some businesses may ask independent contractors to sign an agreement stating that they are not an official employee. However, the answer to the above questions may override this agreement from the IRS perspective.
How Are Employees Classified the Right Way?
Classifying employees, the correct way is critical for a company’s Human Resources and Payroll departments. As you can see, there is a lot of grey area. Even the IRS has difficulty determining behavioral or financial control in some cases.
The good news is that there are payroll service companies that can help you. If you are struggling with the 1099 vs W2 debate, contact us today for expert assistance.