Employee classifications seem like they should be black-and-white: either a worker is a full-time direct employee, or they’re not… right? Yet, in the modern workforce, employee classifications come in quite a few shades of grey. So, when it’s time to decide between a 1099 vs W2 form, it can be challenging to identify which employees need what.
Imagine you’ve just posted a new job opening. The position is fully remote and you’re completely flexible on scheduling. Your employee will be using their own computer, but they’ll be doing a lot of travel for your company and will be reimbursed for all incurred expenses. You’re bringing them on for a specific implementation… but you’re open to keeping them on longer if it’s a good cultural fit. Is this worker a 1099 contractor or a W2 employee? This example shows just how tricky it can be to nail down the different categories of workers.
Unfortunately, classifying your employees incorrectly can lead to many problems when you need to calculate payroll taxes. So, to ensure you’re doing everything the right way, we break down the key differences between 1099 vs W2 workers below, providing you with three IRS-approved tips so you can classify your employees correctly.
1099 vs W2: What is the Difference?
Let’s start by examining the differences between a 1099 vs W2 tax form. Form 1099-MISC is filed by employers on behalf of their independent contractors. Form W2 is used on behalf of regular full-time employees.
Independent Contractors (1099 Workers)
Sometimes called “freelancers” or “consultants,” these workers are technically self-employed and have their duties laid out for them in a written contract. A pro of hiring an independent contractor is that you don’t have to pay payroll taxes on these workers, and they’re also not eligible for benefits like health insurance or vacation time.
These employees have a much more standard relationship with your business. They work according to your business’s schedule, and, in return, your business provides them with the resources they need to perform their daily tasks. Typically, these workers are also eligible for company-sponsored health plans, retirement contributions, and other benefits.
ConnectPay has worked with companies that employ a mix of independent contractors and W2 employees. Sometimes, it can be difficult to determine which classification fits an employee best. If you’re looking for a payroll partner who can help guide you through the process from start to finish, feel free to reach out to our team!
1099 vs W2: The IRS Decides Who’s Who
It’s important to classify your workers correctly right off the bat. If you misclassify a worker – even accidentally – you could end up owing back payments on federal and state income taxes, social security, Medicare, unemployment, and workers’ compensation. You may also have to reimburse your employees for any overtime or minimum wage pay they missed out on.
But how do you prevent classification mistakes and penalties when the lines between a 1099 and W2 worker can get so blurred? Well, the best way is to follow the IRS’s guidelines on employee classifications. When deciding whether a worker needs a 1099 or W2 classification, the IRS considers three main attributes: a worker’s behaviors, financial situation, and relationship with the business. Let’s go ahead and examine these in more detail:
If your business directly controls a worker’s behaviors—including when, how, and where they work—they are most likely a W2 employee. The less instruction a worker has, the more likely they will be a 1099 contractor. This piece also goes hand-in-hand with how much training you offer your employee, and how you evaluate them after project completion. If a worker must go through a rigorous training process and their performance is evaluated consistently, then they’re probably a W2 employee. If they’re self-taught and only measured based on the results of a final project, then they’re probably an independent contractor.
The IRS also evaluates how much of an investment a worker has to make upfront to engage in their work. For example, 1099 workers will typically purchase their own equipment like laptops, while employers will typically give W2 employees the tools they need to get a job done. If a W2 does have any business expenses, they will likely be reimbursed by the company. On the other hand, a contractor will generally eat that cost. Lastly, W2 employees usually work on a regular and consistent wage. 1099 contractors are usually paid hourly or via commission.
It’s also important to keep in mind that even if you have a written contract defining whether someone is an employee or a contractor, the IRS does not deem that as sufficient proof. Instead, an employee’s direct relationship with a business is more important to the IRS. For example, if a worker’s relationship with a business is supposed to extend indefinitely, then they are probably a W2 employee. In contrast, a worker hired for a specific time is likely a 1099 contractor.
If you’re still in doubt about an employee’s classifications, you can always ask the IRS directly by submitting Form SS-8. Once submitted, the IRS will make an official determination as to a worker’s classification. However, keep in mind that this process can take up to six months to complete—so if you don’t have time to spare, a better option may be to work with a payroll provider who can navigate the world of classifications and payroll taxes for you.
Understanding 1099 vs W2: Never Misclassify Your Workers Again
With these tips, you should be able to classify your workers with confidence! By understanding the IRS’s guidelines around a worker’s behavioral, financial, and relational ties to your business, you’ll have a roadmap to make better decisions when deciding between a 1099 vs W2 worker.
Of course, we know worker classifications are hardly the only challenge when it comes to small business payroll. To learn more tips and tricks that will keep your small business running at peak efficiency, check out our free resource The Connected Guide to Small Business Payroll!