1099 Vs. W2 Employees

 

One of the first steps for many companies as they grow is to bring on help.  Collectively, small business owners may say, “I’ve got to hire some people.” But this statement can imply several different types of hired help.  
In the United States, it can mean one of two things:  an employee or a contractor.  An employee will be issued a W2 at the end of the tax year and a contractor will receive a Form 1099.   

There are important differences between the two, and while many small businesses like the idea of a 1099 Contractor, there are some important things to remember as the company that employs the contractor.   More importantly, the laws regarding employment often have stiff penalties for intentionally misclassifying employees.  A verdict several years ago against a newspaper for classifying paper carriers as contractors was well in excess of $10 million dollars!

Who is a W2?

Put simply, a W2 employee is just that – an employee.  All of their training will be provided by the company, they will have a specific manager that they will report to, and they will follow the schedule that company sets for them.  An important distinction is that these employees will be provided the tools they need to do the job they were hired for.  (You can see how this can get “messy” when thinking of skilled workers in a shop environment who may need thousands of dollars’ worth of tools!)

In exchange for their time, the worker’s will be compensated and will likely have the chance to participate in various other benefits – retirement plans, medical insurance, and paid vacation time.  The employer will handle all Social Security, Medicare, and withholding taxes in the worker’s paycheck and document that for them and for the IRS each payroll period.

Who is Considered a 1099 Contractor?

Many companies like the idea of an Independent Contractor (1099) – they have very little liability, there is only limited accounting for the expenses, and most training and materials costs are pushed off on to the contractor.  All this comes with one big drawback, though, and that is control.  The term “contractor” does denote that a contract has been signed, or at least implied, so the contracting company is limited in the amount of control they can exert to get a particular job done by the contractor.  

Legally, 1099 Contractors are. In most cases, allowed to set their own schedules and are expected to use their own systems (versus the company retaining them) to complete jobs.  The term “contract” implies one particular job has been accepted and that is how the law also sees it – contractors accept jobs on a case-by-case basis and can turn down work as they choose.  Critically, they can have more than one client.  

There are any number of differences, but we tracked down this handy chart that UpWork (a business and marketing freelancer service) uses to help guide companies.  

upwork-1099-w2-table


 Which Type of Status is Right For Your Small Business?

Choosing how to structure your staff – whether as contractors or employees – is a critical step in your small business plan.  For operators in brick-and-mortar operations, such as retail or restaurant, you’ll likely not have any choice but to make your staff W2 employees.  The advantage, of course, is that you’ll have the ability to exert control, training, and standards to make sure that your customer experience is to the level you set.

One potential exception is for retailers who have outside sales representatives.  Depending on how that staff is organized, you may determine (with the help of tax professionals) that they can be defined as 1099 Contractors.
THAT is the critical part of determining how to classify your employees.  If you “push” employees into contractor status, then you run the risk of considerable legal and tax problems if that is challenged in court and you are found to be wrongly classifying your employees.  

One other tool that we often recommend is right here.  This is the IRS’ page that defines employment both for businesses and for individuals.  Ultimately, this definition is the law that will hold companies and individuals accountable.  While the actual legal terminology introduces additional terms into the lexicon – such as “statutory employee” – this is a fantastic site to ensure your hiring status is correct and that you are managing your staff properly.  

 

By: Chris Groote

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