As a business owner, you’re faced with decisions that impact your team and your company culture every day.
At some point, you'll ask yourself when it's appropriate to outsource a certain job or service. Instead of onboarding a new employee, you may opt to hire an independent contractor to accomplish the task. For example, you may hire an accountant to handle your taxes, an electrician to rewire your office space, or an illustrator to design a logo.
At Whirks, we recognize the value of leaving certain things to the experts. It helps you avoid making a potentially expensive mistake (like your taxes), a dangerous one (like electricity), or an ineffective one (don't DIY your logo).
In this article, we outline the differences between an independent contractor, or 1099, and an employee, or W2.
W2 Employees vs. 1099 Independent Contractors
What is a W2 Employee?
A W2 employee works directly for your business, under your direct or indirect supervision. You control their schedule, assign tasks, and provide the tools or equipment they need to do the job.
As the employer, you’re also responsible for handling payroll taxes, including Social Security, Medicare, and unemployment, and may provide benefits like health insurance or paid time off.
For more on correctly classifying workers, read FLSA classifications for Hourly vs. Salaried Workers.
What is a 1099 Contactor?
An independent contractor is an individual who performs a service for you, usually at a pre-arranged fee. For each service rendered, you receive an invoice from them. You don’t withhold taxes from their payments and it’s up to them to handle their own tax obligations.
Compared to an employee, you do not control the hours worked or the tools used, and they don't have major responsibilities at your company, such as managing or supervising your team.
Additionally, they also need to possess:
- A business card
- A contract or work order with the business owner
- A business license number (issued to them by the city in which they work)
- Evidence of being licensed by the state (think doctors, lawyers)
*Please note that this is only a portion of what determines a worker's status.
Some examples of independent contractors can include:
- Janitors
- Plumbers
- Accountants
- Lawyers
- Electricians
- Landlords
- Painters
- Consultants
- Salespeople
- Doctors
Why Misclassifying Employees Can Cost You
It isn’t just a technicality—it’s a legal line in the sand. Misclassifying workers is one of the fastest ways to end up on the wrong side of an IRS audit, facing penalties and back taxes that could seriously hurt your business.
Sometimes, misclassification is an honest mistake (hey, running a business is stressful!) but other times, it's an attempt to avoid legal requirements and expenses, such as:
- Overtime
- Social Security and Medicare taxes
- Paid Time Off
- Unemployment
- Workers’ compensation
While hiring employees requires more responsibility and a greater investment as a business owner, there are major consequences to misclassifying an employee as a contractor, such as:
- Paying back taxes
- Penalties for not reporting employee earnings
- Penalties for delinquent withholding payments
- Being classified as a repeat offender (OSHA and the DOL don't like this)
The National Employment Law Project states that 10 to 30 percent of employers (or more) misclassify their employees as independent contractors, indicating that several million workers nationally may be misclassified.
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Because of this, the Department of Labor and the IRS have become stricter with businesses in order to ensure the rights and responsibilities of both employers and workers.
Requirements for Independent Contractors
Once you've hired an independent contractor, have them fill out a W-9 form prior to paying them.
If they don't want to fill the form out, or you can't acquire their identification number, you're required to withhold 24% of each payment.
This is known as backup withholding. The money is forwarded to the IRS, just like payroll taxes. Once it's withheld from the payment, you do not refund it to the contractor or pay it back in any way.
For example, let's say you hire an electrician, and he hands you an invoice for $800. You ask him to fill out a W-9, and he says he doesn't have the information he needs with him to do that.
At this point, you can give the electrician two choices:
- Wait to collect payment until the W-9 is filled out, or
- Pay him $576.00 immediately, with $224 sent to the IRS
We recommend taking a firmer approach with independent contractors and requiring them to fill out the W-9 before you make any payments to them.
When you are required to submit your 1099s to the IRS at the end of the year, it protects you from the following penalties:
- $50.00 for each ID number missing from the 1099
- $50.00 for each 1099 not submitted
As an extra step, try to enter into a written agreement with the contractor and review it with your attorney.
Download Contract SampleHow to Classify Workers Correctly
The IRS outlines three factors to help you determine whether your worker is an employee (W2) or an independent contractor (1099).
1. Behavioral: Do you control what the worker does and how they do it?
2. Financial: Are parts of the worker's job controlled by you, such as tools and supplies?
3. Relational: Are you offering benefits? Is this job key to the success of your business?
The IRS criteria differ from the factors outlined by the Department of Labor when determining worker status for the Fair Labor Standards Act. While the IRS outlines how much the employer controls, the FLSA goes into the financial aspects of a W2 or 1099 worker.
To classify your employee under the IRS or FLSA guidelines, download our free assessment.
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