W-2 vs. 1099: A comprehensive guide for employers

W-2s and 1099s are much more than tax forms. They represent two types of workers: traditional full-time employees and self-employed contractors. These tax classifications also carry distinct financial and legal implications, so it’s important to recognize the nuances of each before building a hiring plan.

This post will clarify the differences between W-2s and 1099s, help you understand each classification's legal and tax consequences, and explain the steps involved in paying each. 

What’s a W-2 form?

The W-2 is a mandatory annual tax form employers must complete and provide to current or former employees who receive more than $600 in compensation. Employees use the information in their W-2s to complete their federal and state tax returns, so most businesses issue them early in the first quarter. 

The W-2 contains information about gross wages paid to an employee, as well as federal income tax, Social Security, and Medicare withholdings. It also includes information about state income tax withholding and employee benefits. 

What's a 1099 form?

Like a W-2, a 1099 form lists all the compensation paid to an independent contractor. It's required when the total value of payments a business makes to a contractor exceeds $600 in a calendar year. 

Businesses typically issue two types of 1099: the 1099-NEC and the 1099-MISC. The 1099-NEC covers payments made to an independent contractor for services, while the 1099-MISC covers royalties, attorney fees, cash prizes, and other income payments.

What’s a W-2 employee?

A W-2 employee is named after a form issued by the IRS to report wages and taxes paid to an employee of a company. According to one recent survey, 92% of people filing a tax return in the US reported their income based on a W-2 issued by their employer. 

According to the IRS, every employer “engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year” (essentially any company that pays for their employees’ services) must file a Form W-2.

W-2 employees are typically subject to the employer's direction and control in their work performance. Their employer withholds federal and state income tax, Social Security tax, and Medicare tax from their paychecks. The employer is also responsible for paying unemployment tax and a matching amount for the Social Security and Medicare taxes.

W-2 employees may be entitled to benefits like healthcare and retirement plans, and their employer must comply with various employment laws and regulations that apply to employees, including minimum wage, overtime, anti-discrimination, and workers' compensation laws.

 What’s a 1099 worker?

A 1099 is a form issued by the IRS used to report payments made to an independent contractor or self-employed individual. Unlike W-2 employees, 1099 contractors are considered self-employed and responsible for paying their own taxes, like federal income tax and self-employment tax. They are also responsible for their business expenses and finding, registering for, and paying for their benefits, including health insurance and retirement plans.

1099 contractors are typically hired for a specific project or task. Their contracts dictate the business’s level of direction and control over their work. In some cases, contracts may require a 1099 contractor to work onsite, whereas others may permit them to work wherever they like. Typically, however, an independent contractor is not subject to the level of managerial control a W-2 employee may encounter. 

So, what’s the difference between 1099 and W-2?

Understanding the difference between 1099 independent contractors and W-2 employees can be tricky. The table below highlights the main differences. 

W-2 employees and 1099 contractors also differ when it comes to payroll taxes and employee benefits. What you gain in terms of oversight and stability when you hire a W-2 employee, you typically pay for in higher payroll taxes and benefit costs.

Employers are required to withhold income taxes and FICA taxes for Social Security and Medicare from a W-2 employee's wages.  1099 contractors on the other hand, receive all their compensation up front and pay their self-employment taxes once a year. 

Regarding benefits, W-2 employees receive protection from federal minimum wage and overtime laws. They can also claim paid time off work under the Family and Medical Leave Act (FMLA). If a W-2 employee is laid off or injured on the job, they can claim benefits from programs like workers' compensation and unemployment. In most states, employers with more than 50 employees must offer employees health insurance. 

1099 contract workers aren't entitled to employer-sponsored benefits and can't claim either workers' comp or unemployment. 

Examples of W-2 and 1099 workers

The decision to hire W-2 employees or 1099 contractors can depend on a number of factors, including the type of work to be performed and your specific business needs. 

Let's look at a few examples to better understand the distinction between W-2 employees and 1099 workers.

W-2 employees might look like:

• Staff writers and designers with fixed hours and ongoing assignments
• Delivery drivers with a set route who use company vehicles and wear a uniform
• Project managers for multi-year initiatives or a product in continuous development

1099 workers might look like:

• Freelance writers and designers hired for a short-term project with specific start and end dates
• Drivers who choose to accept specific fares or routes and set their own hours
• Project managers for a single assignment or one-off initiative

If you're unsure how to classify a worker, consult a labor and employment attorney. 

Benefits and drawbacks of hiring W-2 employees

W-2 workers and 1099 independent contractors have benefits and drawbacks, and the best hiring decision for your business will vary. If you’re not sure which type of relationship would most benefit you, consider the following:

Advantages of hiring W-2 employees

1. Consistency and culture: A W-2 employee is a permanent employee, which means they are available for work consistently. Because of this consistency, a company with W-2 employees will have a stable workforce. Consistency and stability can also contribute to establishing a positive and enduring company culture.
2. Greater control: Businesses have more control over the work and productivity of W-2 employees than independent contractors, with the legal ability to manage their work in accordance with company policies.
3. Range of duties: You have much more freedom in the types of tasks you can assign to a W-2 employee, provided the employee has the skills, materials, and tools to perform them.

Disadvantages of hiring W-2 employees

1. Turnover risk: Hiring, onboarding, and training W-2 employees requires a great deal of time and effort, making them difficult and expensive to replace if you encounter fit problems. 
2. Administrative burden: Managing the administrative processes associated with W-2 employees can be complex and time-consuming. 
3. Limited flexibility: W-2 employees may not offer the same flexibility as independent contractors, who can work on a project-by-project basis. Reducing headcount without incurring significant costs or negatively impacting morale is also difficult.

Benefits and drawbacks of hiring 1099 workers

Advantages of hiring 1099 contractors

1. Access to a large talent pool: Because you’re not hiring a permanent employee, you can expand your search beyond your usual geographic or salary constraints. 
2. Flexibility: 1099 employees can work on a part-time, per-project, or short-term basis, depending on your business needs.
3. Specialized skills: 1099 employees may have specialized skills and expertise that are either unavailable in-house or too inconvenient to hire, onboard, and train a new W-2 employee to utilize.

Disadvantages of hiring 1099 contractors

1. Limited control: Businesses may have limited control over 1099 contractors’ work as they are not considered employees and work independently.
2. Limited range of tasks: 1099 contractors typically provide specific services itemized in a contract. Adding new work or asking for additional help will require negotiating new terms.
3. Dependability: 1099 employees may have limited availability, as they typically have other clients or commitments.

Tax implications for W-2 employees and 1099 contractors

W-2 employees

Subject to federal income tax, Social Security tax, Medicare tax, and unemployment insurance, all of which are withheld from their paycheck by the employer. The employer is also responsible for paying a matching amount for the Social Security and Medicare taxes.

While employers are responsible for paying state and local payroll taxes, depending on the state and company size, they may not be legally obligated to provide benefits like healthcare and retirement plans.

Each tax season, W-2 employees receive a W-2 form from their employer, which summarizes their total wages and tax withholding for the previous year. They use this form to file their personal income tax return, due on April 15 of the following year.

1099 contractors

1099 contractors are responsible for paying their own federal income and self-employment taxes, including the employer and employee portions of Social Security and Medicare taxes. Depending on their location, they may also be responsible for paying state and local taxes.

1099 contractors are not entitled to employee-type benefits such as healthcare and retirement plans.

1099 contractors receive a Form 1099-NEC from each client who paid them more than $600 during the year. They use these forms to report their income on their personal income tax return, which is due on April 15 of the following year.

Legal implications of employee misclassification for business owners

Misclassification of employees or contractors—whether intentional or not—can have significant legal consequences for both the employer and the employee or contractor. An employer with misclassified workers may be liable for back wages, taxes, and penalties.

Employers must comply with various employment laws and regulations that apply to employees, including minimum wage, overtime, anti-discrimination, and workers' compensation laws. 

Contractors are generally not entitled to the same legal protections as employees. They are not covered by minimum wage laws, overtime laws, or anti-discrimination laws. They are also not eligible for workers' compensation benefits if they are injured on the job.

If only the IRS were this simple

Rippling can help you onboard employees and contractors in 90 seconds and automatically manage those compliance obligations we mentioned above. 

With Rippling, you get:

• Effortless onboarding: Whether you're hiring a new employee or contractor, Rippling makes it easy to get them up and running quickly.
• Payroll processing with a few clicks: Rippling handles all payroll processing, including tax withholding and reporting for W-2 employees and 1099 contractors.
• Time and attendance tracking: Rippling offers tools that work for hourly employees and contractors.
• Transparent and compliant benefits administration: Rippling makes managing benefits for W-2 employees, from health insurance to retirement plans, easy.
• Simple contractor payments: Rippling provides a streamlined process for paying 1099 contractors, including direct deposit and online payment options.
• Automated compliance management: Rippling helps you stay compliant with employment laws and regulations, from minimum wage laws to workers' compensation requirements.

The bottom line? By using Rippling, you can ensure that both your full-time employees and gig workers—all those W2s and 1099s—are paid accurately and on time, and that you're staying compliant with all relevant laws and regulations.

This blog is based on information available to Rippling as of July 70th, 2024.

Disclaimer: Rippling and its affiliates do not provide tax, accounting, or legal advice. This material has been prepared for informational purposes only, and is not intended to provide or be relied on for tax, accounting, or legal advice. You should consult your own tax, accounting, and legal advisors before engaging in any related activities or transactions.