Compliance Corner: The Pros and Cons of a 1099 Versus a W-2 Worker

The pandemic and technological advances played a crucial role in the rise of independent contractors, with the gig economy flourishing post-2020. Freedom, flexibility, remote work and greater autonomy are a few of the driving factors that led to a departure from traditional employment to a more independent way of working. According to CNBC, independent workers now make up about 45 percent of the U.S. workforce, with nearly 30 million working independently full-time.

While businesses can pay an employee and an independent contractor for the same or similar work performed, there are several factors that must be taken into consideration to determine the classification. In this Compliance Corner blog, Lisa Bright, HR Business Partner on isolved’s HR Services team, highlights important information that employers should know about hiring 1099 versus W-2 workers.

To get started, it’s important to note that the Internal Revenue Service (IRS) provides the following three categories called Common Law Rules to assist in determining the level of control and independence of an employee versus a contractor:

1. Behavioral – Facts that identify whether there is a right to control how work is completed. Three factors used to determine behavioral control are:

• Type and degree of instruction

• Evaluation systems

• Training

2. Financial – Facts that identify if the company has control over economic aspects:

• Investment

• Unreimbursed expenses

• Opportunity for profit or loss

• Services available to the market

• Method of payment

3. Relationship

• Written contract

• Employee benefits

• Permanent employment

• Services provided as an employer-employee relationship

NOTE: A business can also file a Form SS-8 with the IRS to get assistance in determining classification however it can take up to 6 months to get a decision.

Comparing a 1099 Worker and a W-2 Employee

1099 Worker (examples: self-employed, consultant, gig worker, freelancer)

• Hired to perform a specific job within a certain amount of time

• Provides their own tools and resources

• Performs work for multiple companies

• Hired for expertise

• Controls their own method of work

• Does not receive employment benefits or overtime

• Pays their own taxes

• Paid per project or flat fee

W-2 Employee (examples: full-time, part-time, temporary, seasonal, union)

• Company has control over the work performed

• Commits to scheduled hours and place of work

• Usually works for one employer

• Requires training

• Uses company tools and resources

• Paid on an hourly or salary basis

• Receives company benefits such as health coverage or paid time off

• Subject to taxes and deductions

• Protected by FLSA for overtime, wages, and other employment protections

Benefits and Drawbacks

There are distinct benefits and drawbacks for both types of labor.

W-2 Benefits

For employers: W-2 employees often bring a greater sense of commitment and loyalty, are more amenable to changes to duties and responsibilities and are easier to manage.

For workers: W-2 employees benefit from employment protections under state and federal laws. Additionally, the employer shares tax obligations and contributes to other costs such as health care and other employer-sponsored plans.

W-2 Drawbacks

For employers: Employers need to cover the costs of employee resources, such as office space and equipment. W-2 employees also often require training, a cost that is passed on to the employer.

For workers: W2 employees are more dependent on their employer, lack complete control over their schedules and can face limited earning opportunities.

1099 Benefits

For employers: An independent contractor offers an organization more flexibility, lower hiring costs and more specific task expertise. Also, there are no training costs associated with independent contractors.

For workers: 1099 workers benefit from control over their own schedule and taxes, greater income potential and are not connected to one location or organization.

1099 Drawbacks

For employers: Employers cannot exercise significant control over work performed—and must pay contractors for all hours they work, unlike exempt salary employees. There is a degree of risk with misclassification and non-compliant contracts.

For workers: 1099 workers lack the stability that comes with being a W-2 employee. Also, most are ineligible for company benefits and may pay more in taxes.

Come tax time, the distinction for employers is crucial between the two employee categories.

Difference Between 1099 & W-2 Tax Forms:

• A 1099 form shows how much an organization has paid to an independent contractor. This form is provided when a business has paid a minimum of $600 for a service and taxes were not withheld.

• A W-2 form is a Wage and Tax Statement provided to a worker who is considered an employee during a tax year. The W-2 serves as a record of compensation, certain benefits and state/federal taxes withheld.

Misclassification Costs

Penalties for classifying an employee as an independent contractor can be costly—the IRS will go back three years for unpaid taxes.

Finable infractions include:

• Penalty for not filing a required W-2 form

• Failure to withhold wages

• Employer and employee shares of FICA

• Failure to pay tax liability

• Additional penalties may be assessed if the IRS believes misclassification was intentional or fraudulent

What if an Employer has Misclassified a W-2 or 1099 Worker?

The IRS has a Voluntary Classification Settlement Program (VCSP) that allows employers to reclassify workers for tax purposes by completing an application and entering into an agreement with the IRS.

Want to ensure that your organization is maintaining compliance when it comes to 1099 workers? HR Services is here to help!

Resources:

Common Law Rules - Determining Control and Independence

Form SS-8 IC Determination

Independent Contractor or Employee?