1099 vs. W2 Rules: Understanding the Differences and Implications

1099 vs. W2 Rules: Key Differences

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Independent contractors are often called 1099 workers after Form 1099, the year-end tax document they receive from clients each year. Similarly, traditional employees are W2 workers, named for the year-end tax document, Form W2. However, the difference between 1099 and W2 workers goes far beyond tax forms. For starters, it’s essential to understand 1099 vs. W2 rules established by the Internal Revenue Service (IRS). Per IRS worker classification requirements, employers must classify workers as either employees or contractors using the following criteria:

• Behavioral control: How much control an employer has over the work and how it is performed
• Financial control: The degree to which the employer controls the financial and business aspects of the job, for example, how the worker is paid, whether expenses are reimbursed, and who pays for work supplies and equipment
• Type of Employment: Whether there are signed written contracts or employee-type benefits provided

While 1099 and W2 employees can perform the same or similar work, they differ in the following ways:
1099 Contractors

• Have a high degree of control over their work
• Provide their own equipment and work supplies
• Work on a project or commission basis
• Typically have more than one client

W2 Employees

• Perform work according to employer specifications
• Use employer-provided equipment and supplies
• Work on a regular schedule or shift
• Typically work for one employer

Worker Classification Implications For Your Organization

Recent figures reveal a diverse workforce of employees and external workers. According to 2022 McKinsey research, the US workforce comprises 61% W2 employees and 36% independent workers (gig, contract, freelance, and temporary workers). However, regardless of the mix of employees and independent workers you hire, how you classify them will impact your organization’s compliance obligations and bottom line.

Therefore, consider the following implications when classifying workers as employees or contractors:

Financial implications

In general, hiring employees can be more expensive than hiring contractors. Here are three kinds of expenses employers incur when hiring employees vs. contractors:

• Payroll taxes, including Social Security and Medicare
• Unemployment and workers’ compensation insurance premiums
• Costs associated with providing benefits such as paid time off and health insurance

Legal implications 

Hiring employees in the US immediately makes your organization responsible for complying with dozens of federal employment laws, including the Fair Labor Standards Act (FLSA), the Family and Medical Leave Act (FMLA), and many others. Conversely, many employment laws offer no special entitlements to contractors. For example, contractors are not protected by minimum wage or overtime laws.

Despite the limited applicability of employment laws to contractors, there are additional legal implications you should consider. They include:

• Misclassification penalties: Incorrectly classifying employees as contractors can result in hefty penalties levied by the US Department of Labor and other government agencies.
• State-specific classification laws: Some states, such as Virginia, Iowa, and California, have independent contractor laws, some carrying additional non-compliance penalties.
• Potential legislative changes: In late 2022, the Department of Labor announced a proposed rule to change how workers are classified as employees vs. contractors.

Talent management implications

Hiring employees and contractors is rarely just a financial or legal decision. You also need to consider how the mix of workers impacts your organization’s overall talent management strategy. For example, because employees tend to work in a permanent arrangement, you have more control over their work, and you can benefit from their longevity and knowledge of business processes. On the other hand, contractors can bring a specialized skill set to your organization and allow more flexibility when you need talent to fill project-based and short-term needs.
Simplify Worker Classifications for Good

Navigating 1099 vs. W2 rules for classification can make hiring employees and contractors more challenging. But when you manage all of your hiring and classification activities using a single integrated system, it immediately becomes much easier. Worksome Classify helps you classify all of your employees and contractors in compliance with applicable federal and state laws, so you can hire and pay your workforce with confidence. Instead of getting bogged down in manual processes and back-and-forth exchanges over email, you can trust Worksome to help you identify, classify, and pay your workers, all with a centralized compliance platform.To see how Worksome can simplify worker classification and most other aspects of independent contractor management, contact us for a personalized demo today!