The age old debate among contractors: what is the difference between 1099 vs W2 employees?
We have seen so much bad advice online (contractor groups on Facebook, we’re looking at you), so we had to write a blog about it to clear up the confusion.
Here’s the thing: understanding the difference between 1099 and W2 workers isn’t just important—it could mean the difference between a smooth business operation and the Department of Labor and the IRS issuing you fines and taxes that bankrupt you. So, listen up.
The Basics: 1099 vs W2 Employees
Let’s cut to the chase. The terms “1099” and “W2” refer to different tax forms, but they represent two distinct types of workers:
- 1099 workers are independent contractors (and therefore, shouldn’t even be referred to as 1099 employees!)
- W2 workers are employees – either part-time, seasonal or full-time.
Sounds simple, right? Well, not so fast. The distinction between these two categories goes beyond taxes. It’s a legal matter that can have serious financial consequences in your business.
Why Does It Matter?
Misclassifying workers isn’t just a whoopsie—it’s a potential legal and financial nightmare. Get it wrong, and you could be looking at:
- Hefty fines and penalties
- Back taxes
- Legal battles that eat up your time and money
In other words, it’s not something you want to get wrong. So let’s dive into the nitty-gritty of understanding the difference between 1099 & W2 employees.
What Makes a W2 Employee?
According to the Department of Labor, an employee (W2 worker) typically:
- Works exclusively for one employer
- Has set work hours determined by the employer
- Uses the company vehicles or uniforms
- Receives training from the employer
- Uses tools and equipment provided by the employer
- Has work that is integral to the business’s operations
- Is subject to performance evaluations
- Receives benefits like health insurance and paid time off
- Has taxes withheld from their paycheck by the employer
For example, if you have a salesperson that sells exclusively for you, drives your branded trucks, wears your uniform shirts, hands out your company business cards and you determine their schedule: they are legally an employee, not a 1099 subcontractor.
What Makes a 1099 Contractor?
On the flip side, a 1099 contractor usually:
- Works for multiple clients
- Sets their own schedule
- Uses their own methods to complete work
- Provides their own tools and equipment
- Offers services that are outside the client’s core business
- Is responsible for their own taxes
- Doesn’t receive employee benefits
- Can subcontract work to others
For example, the drywall crew that bids a job for you, wears their own uniforms, sends you estimates and invoices, and determines their own schedule while working for multiple contractors is a 1099 subcontractor.
Click here for more information about how to file 1099’s, what to collect, when to file them.
The Department of Labor Weighs In
The Department of Labor (DOL) doesn’t mess around when it comes to worker classification. They use what’s called the “economic realities” test to determine if a worker is an employee or a 1099 independent contractor.
According to the DOL, the key factors are:
- The extent to which the work performed is an integral part of the employer’s business
- The worker’s opportunity for profit or loss depending on their managerial skill
- The extent of the relative investments of the employer and the worker
- Whether the work performed requires special skills and initiative
- The permanency of the relationship
- The degree of control exercised or retained by the employer
Notice a theme? It’s all about control and independence. The more control you have over a worker, the more likely they are to be classified as a W2 employee than a 1099 subcontractor.
Common Misconceptions about 1099 vs W2 Employees
Let’s bust some myths, shall we?
- “I can choose how to classify my workers.” Wrong! The classification is determined by the nature of the working relationship, not by your preference or the worker’s.
- “If they sign an agreement saying they’re an independent contractor, we’re in the clear.” Nope! A written agreement doesn’t override the actual working relationship.
- “Part-time workers are always 1099 contractors.” Not necessarily. Many part-time workers are still classified as W2 employees.
- “Paying someone as a 1099 contractor is always cheaper.” While it might seem that way at first, misclassification can end up costing you way more in the long run.
The Consequences of Misclassifying 1099 & W2 Employees
Still thinking about rolling the dice on worker classification? Here’s why that’s a bad idea::
- Back taxes: You could be on the hook for all the employment taxes you should have been paying. I’ll give you a word of advice: there is nothing the IRS is stricter about than employment taxes.
- Penalties: The IRS isn’t known for its leniency. Expect to pay up for your mistake.
- Legal fees: When the DOL comes knocking, you’ll want a good lawyer. That doesn’t come cheap.
- Damaged reputation: Nothing says “sketchy business practices” like a worker misclassification scandal.
- Loss of business: Some clients might not want to work with a contractor who’s in hot water with the government.
How to Get it Right: Choosing 1099 or W2 Employees for your Business
So, how do you stay on the right side of the law? Here are some tips:
- Assess each working relationship individually. Don’t assume all your workers fall into the same category.
- Use the DOL’s economic realities test as a guide.
- When in doubt, err on the side of classifying a worker as an employee. It’s generally safer.
- Keep detailed records of how you classify workers and why.
- Stay up-to-date on changes in employment law. The rules can and do change.
- Consider using a reputable payroll service to help manage your workers.
The Bottom Line
The 1099 vs W2 employee debate isn’t just about paperwork—it’s about running your contracting business the right way. Getting it wrong can cost you big time, but getting it right can set you up for smooth sailing.
Remember, this isn’t just about following rules. It’s about creating a fair and legal working environment that benefits both you and your workers. When you classify your workers correctly, you’re not just protecting your business—you’re building a foundation for long-term success.
Need Help Navigating the 1099 vs W2 Employee Maze?
At Level Accounting & Advisory, we’re more than just number crunchers. We’re a full-service accounting firm specializing in the trades. We understand the unique challenges contractors face, and we’re here to help you make sense of it all.
From worker classification to tax planning and everything in between, we’ve got your back. Don’t let employment classification confusion hold your business back. Reach out today, and let’s build a solid financial foundation for your contracting business.
Like this post? Check out our other blogs:
- 1099 vs W2: What Contractors Need to Know About Hiring
- BOI Reports: Your How To Guide to Filing
- Cash vs Accrual Accounting for Construction Businesses
- 1099s: Everything Contractors Need to Know
- Why Should Contractors Consider an S-Corp Election
- How to Pay Yourself as an S-Corp Owner
- More can be found Here
Disclaimer: This article provides general information and should not be construed as tax, legal, or accounting advice. Always consult qualified professionals for guidance specific to your situation.
