Why It’s Crucial to Classify Your Employees Correctly (1099 Contractors vs. W-2 Employees)

Why It’s Crucial to Classify Your Employees Correctly (1099 Contractors vs. W-2 Employees)

In the United States, W-2 is the standard employee classification, while 1099 contractors are independent freelancers, contractors and other short-term workers. Misclassifying a W-2 employee as a 1099 contractor carries hefty financial, legal and sometimes even criminal penalties — but figuring out the difference between 1099 contractors vs. W-2 employees can be tricky.

In this guide, we break down the differences between these two employee classifications.

1099 contractor vs. W-2 employee

In the United States, 1099 contractors are independent contractors, freelancers, self-employed workers or gig workers that are not considered employees of a business. They are so-called because they receive a 1099 form at the end of the calendar year.

W-2 workers are considered employees of a business, and they may be full-time or part-time. They are called this because they receive a W-2 form at the end of the year. The chart below summarizes the main differences between 1099 contractors vs. W-2 employees:

1099 contractor
W-2 employee
Considered self-employed
Considered an employee of the business
Pays taxes on a quarterly basis
Taxes withheld from each paycheck
Not on payroll
On payroll
Business doesn’t provide benefits
Business provides benefits
More autonomy,
individuals often decide when and how they work
Less autonomy,
company decides when and how they work
Often uses own equipment and resources
(i.e. personal laptop)
Often uses business equipment and resources
(i.e. company laptop)
Not always eligible for unemployment
Eligible for unemployment
Often works for multiple clients at once
Works for one company at a time
Can deduct business expenses
Can’t deduct many business expenses
Frequently hired on a project-to-project basis
Longer ongoing commitment and relationship with the company

Why 1099 vs. W-2 classification matters

Misclassifying an employee as the wrong type carries steep penalties in the U.S. Depending on the situation, employers may be required to pay some of all of the following expenses if they misclassify a W-2 worker as a 1099 contractor:

  • Tax violation fines for unpaid Social Security, Medicare, FICA and income taxes.
  • Payment penalties of up to $1,000 per person for wage and labor violations, such as the rights to benefits like overtime pay and minimum wage.
  • Unpaid premiums for unemployment insurance and workers’ compensation.
  • Back wages and benefits for the period of misclassification.
  • Legal costs from disputes and class action lawsuits.

In addition to these financial penalties, misclassifying employees can seriously harm your company’s reputation. Misclassified employees may quit the company altogether and warn other prospective employees to stay away. If this happens, your company may struggle to attract top talent, which will have cascading effects throughout the entire business.

Examples of 1099 vs. W-2 workers

Both 1099 and W-2 work can take many different forms. Here are some examples of both types of workers to further clarify the difference:

1099 workers

  • A consultant working on a time limited project.
  • Freelancer talent such as writers and photographers.
  • Gig workers hired to complete a certain task or project.
  • Contract workers hired through a temp agency.

W-2 workers

  • Hourly employers working in customer service jobs.
  • Salaried employees working in an office.
  • Executives and managers at an organization.

1099 contractor payment and taxes

How a 1099 contractor gets paid

Typically, 1099 contractors get paid through invoicing. The invoices may be submitted according to a certain schedule (such as once a month) or at certain project milestones (such as at completion). Payment terms can range from payment on receipt to 30 days to 60 days. Contractors may be paid through cash, check or direct deposit. The best payroll software, such as Gusto, makes it easy to pay 1099 contractors and W-2 workers through the same platform, so you can keep everything centralized.

What taxes do 1099 contractors pay?

There are a couple of taxes that 1099 contractors must pay, starting with the entire self employment tax. The self employment tax rate for 2024 is 15.3%, with 12.4% going to Social Security and 2.9% going to Medicare. They must also pay federal income tax, and the rate for that varies based on income bracket. If 1099 contractors expect to owe more than $1,000 in taxes for the year, then they must pay estimated quarterly taxes. They may also be responsible for additional taxes, such as state income tax.

W-2 employee payment and taxes

How a W-2 employee gets paid

W-2 employees may earn either a salary or an hourly wage and are paid during regular payroll runs. Most businesses have a bimonthly or every-other-week payroll schedule, while a few follow a weekly or monthly schedule. Most W-2 employees are paid through direct deposit, though some might be paid through cash or check if they request it. Taxes are withheld from each of their paychecks by the employer — payroll software like Gusto automates these calculations and deposits to reduce errors.

What taxes do W-2 employees pay?

Taxes are structured differently for W-2 employees, with the payment split between workers and employers. For each paycheck, 6.2% will be withheld for Social Security and 1.45% for Medicare, for a total of 7.65%. Employers then match that same amount, doubling the amount of tax paid to 15.3% — but only half of that comes out of the employee’s paycheck, unlike 1099 contractors. The appropriate amount of federal and state income tax will also be withheld from each paycheck, depending on what income bracket the employee falls into.

Which type of worker should you employ?

Still unsure where you should be hiring a 1099 contractor or a W-2 employee? You should consider hiring a 1099 worker if:

  • You only need them for a short amount of time, such as for a specific project or to cover maternity leave.
  • You have a specific skill gap on your in-house that you need to fill temporarily, like hiring an IT expert to help with a software migration.
  • You need the worker to do less than 30 hours of work a week.
  • You don’t care if the person does work for other companies at the same time.
  • You don’t expect to control when, where or how they get work done.

You should consider hiring a W-2 worker if:

  • You need them to perform more than 30 hours of work this week.
  • You are looking to keep them on for a long time, perhaps indefinitely.
  • You have an ongoing relationship with the worker, and vice versa.
  • You expect some level of control over how the employee does work, such as requiring them to work certain hours or come into the office.
  • The work they will be performing is fundamental and integral to the business.

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