How a 1099 works

How a 1099 works

As a small business owner looking to hire, you’ve probably wondered whether your position is better filled by a traditional W2 employee or an independent contractor (a 1099). In this article, we’ll discuss the pros and cons of a W2 vs 1099 employee, the laws behind employee classification, and the steps to hiring both kinds of employees. This article will explain:

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The 3 Main Differences between W2 vs 1099 Employees

Many businesses make decisions about whether to hire full time (or part time) employees or independent contractors as their business expands. There are a number of reasons you might want to hire one over the other, but let’s first discuss the main differences between a W2 and a 1099 contractor:

When you hire a W2, you take on a lot of costs associated with their employment. This includes Social Security, Medicare, worker’s compensation, unemployment insurance, and a number of other pieces of paperwork that you need to file with your state and with the federal government. You can read all about what you need to do in our how to do payroll guide. When you pay your W2s, you’ll also be taking out their state and federal taxes, Medicare, and Social Security tax.

With independent contractors, they are under what’s called a 1099. While you need to file a 1099 form and also give them one at the end of the tax year, you do not need to pay payroll taxes, worker’s compensation, or unemployment for them because they are NOT an employee. However, this kind of employee has recently become much more regulated. If you have a contractor who is full time, 30 hours or more per week consistently for 90 days, in the government’s eyes, they are very likely an employee and can claim unemployment on you.

W2 and 1099 workers are treated differently when it comes to your ability to terminate (aka fire) them. The main difference is a clause called at will employment.

  • With a W2 employee, you can exercise what’s called at will employment and terminate their employment at any time. You usually find these clauses in employment agreements and employee handbooks. That said, you need to comply with all federal and state labor laws, which are meant to provide boundaries for employee dismissal.
  • With a 1099, you need to pay attention to the terms of the contract you are signing and to your right to terminate it. We recommend a 5-10 day notice of termination from either party.

Finally, the last major notable difference between a W2 vs 1099 employee is that they might and should be paid in different ways.

  • With a W2 employee, they will most likely be salaried and either full time or part time with a consistent schedule.
  • With a 1099 employee, you may pay them on a different schedule, such as on a monthly invoice or on a project basis. Their payments should not be done in the same batch as payroll and they should instead be on a contractor payroll or a vendor payment basis, which payroll software can help you with.

While there are other differences between W2 vs 1099, those are the big 3 to know about before you decide on which kind of employee to hire.

The IRS says that there are 3 main questions to ask yourself about classifying W2 vs 1099 team members at your business. Note that, in general, only ONE of the below questions has to fit the bill for the employee to be considered a W2 employee.

  1. Behavioral question: Does the company control or have the right to control what the worker does and how the worker does his or her job?

If the answer is “yes,” s/he is likely a W2. If the worker is free to manage their own schedule and work process, they are more likely a 1099.

  • Financial question: Are the business aspects of the worker’s job controlled by the employer? (these include things like how worker is paid, whether expenses are reimbursed, and who provides tools/supplies)

    If the company controls how the worker is paid and pays for expenses and supplies, s/he is likely a W2. If the worker has to send an invoice to get paid and/or cover their own expenses, they are more likely a 1099.

  • Type of relationship question: Are there written employment contracts (versus projects or an independent contractor agreement) or employee-type benefits (e.g. health insurance, vacation pay)? Will the working relationship continue for the foreseeable future if the work is done correctly and is the work performed a key aspect of the business?

    If the company provides an employee benefits and believes the employee is there for the long-term, s/he is likely a W2.

  • These questions are useful to ask yourself in addition to our questions below in determining what kind of employees you already have, as well as what you want to hire.

    Some business owners really love 1099 contractors because of their advantages over W2 employees. Here are the top 8 advantages (we go over the opposite in a section below):

    1. You Save on Wages – You can work with people from lower wage countries and, assuming you pay by the project, you don’t pay for downtime or time they spend learning how to do the project.
    2. You Save on Taxes – When hiring employees you not only have to withhold their taxes but your company also has to pay Social Security, Medicare, and unemployment taxes. This is over and above what the employee pays. Independent contractors pay all their own taxes.
    3. You Save on Insurance – Most states require you to buy workers compensation insurance for employees. This is not required when working with independent contractors.
    4. You Save On Benefits – Many full time employees expect benefits such as healthcare, 401K plans, and paid time off. Independent contractors will not expect benefits.
    5. It’s Harder to get Sued – You are not subject to the same labor laws with independent contractors as you are with employees. We list out federal labor laws here and remember, just watch what you put in their contract and be sure to include an “out” clause.
    6. Specific Skill Sets – Many contractors bring an expertise in their field, like technical recruiting or computer development in a specific language. This can save you time on training your current employees to learn additional skills.
    7. You Have Much More Flexibility – Pending your agreement with the independent contractor, you can generally use them as an on-demand resource and “dip in and out” as your business requires.
    8. Good Independent Contractors are Easier to Manage – They are usually incredibly self-motivated and driven since they essentially run their own business. The more hours and projects they can get, the harder they work and with a high level of achievement.

    There are drawbacks to having a 1099 contractor on staff. Here are our top 3:

    1. Higher Hourly Rate – In general, a contractor will charge more by the hour than a salaried team member would. However, you can explore contractors from other countries via websites like Upwork and potentially save money.
    2. Teamwork – Since a contractor is an outsider, they may not “gel” with your team the way an in-house employee would. You’ll want to make sure they understand company structure and their place in it early, as well as create a communications plan with them (i.e. weekly calls or updates).
    3. Capacity if You Need Them More – If an emergency comes up, your 1099 isn’t going to necessarily work late or burn the midnight oil, especially if they have other clients. A W2 team member will usually work, with reason, to get the job done even if that’s overtime.

    Let’s now talk about the flip side– why you might want a W2 over a 1099 contractor to work for your business.

    What about the perks of hiring a full time or part time employee to your business (regardless of hourly vs salary)? There are 5 major perks to posting a job and hiring it as a W2 employee:

    1. Recruiting- For recruiting purposes, you’ll get a lot more applicants and a wider talent pool will be interested in the role. It’s also a lot easier to post the position on a more traditional job board than a contract role.
    2. Succession Planning- As your business grows, you’ll need to promote people and have managers. Hiring W2s allows for this in a more consistent way, and it lets you have people “on deck” or able to help if someone unexpectedly resigns or needs to be fired. A contractor can’t typically help in those situations.
    3. Accountability- A W2 will know that their employment, and potentially benefits, are on the line with their performance. They, in general, are more accountable than contractor. However, people are people and there are great contractors out there, as well as unreliable employees, as we all know too well.
    4. General Help for Company-Say somebody calls in sick or resigns; a W2 person is going to be there to help and be a hand on deck. A contractor who is remote won’t typically be able to help.
    5. Teambuilding & Company Culture- In general, W2s contribute to a more cohesive company culture. They may become great work friends and great long term employees for you as a team. It is harder for 1099s to do this, especially since they are typically off site and usually not consistent in their hours.

    On the other hand, as we’ve touched on before, there are also some downsides to W2 employees.

    The top 3 cons of hiring W2 employees are:

      1. Taxes- You gotta pay payroll, unemployment, and worker’s compensation for all employees. That can start to add up and should be considered whenever you hire in the employee’s total cost to the company.
      2. Harder to Fire- You need to make sure you are implementing things like performance reviews and progressive discipline for behavior issues in order to make sure that you are airtight in firing someone. Even though most states are at will, a W2 is harder to let go of.
      3. Require More Time To Manage- A W2 needs to be trained, is going to have a ton of questions, and needs to be groomed into their role. They can take 30, 60, 90 days or even a full year before they are completely trained up and ready to go. Since a contractor is usually specialized, they can make an impact more quickly.

    How to Know Which To Hire- 3 Questions To Ask Yourself

    So now that you know the difference between a W2 vs 1099, you might be wondering, well, which one do I pick? And why? Some basic questions you need to ask yourself are:

    Question 1: How many hours do you need this person to work consistently each week?

    The barrier is around 30 hours per week. Some laws might say 32 hours per week, but to be safe, we recommend 30 hours per week as the boundary.

    • If you need someone for 30 hours or more per week for the long-term future, you are looking at a W2 employee.
    • If you know the role will have inconsistent hours or does not need to be around for the long-term (i.e. less than 90 days), a contract 1099 employee makes more sense.

    Or maybe you are not sure on hours, or it could depend on the amount of business you have. So let’s dig deeper.

    Budget matters when it comes to a W2 vs 1099. Why? Because a contractor 1099 employee will charge you more per hour than a W2 at a salaried rate, but a W2 will cost you more in consistent payroll and in payroll taxes.

    However, if there is inconsistent work relating to question 1… you need to start weighing a few options:

    • Should you hire a contractor at a higher hourly rate, or should the contractor be billed on a project basis (project cost to be determined beforehand)?
    • Should you hire on-demand talent from a site like Upwork where most freelancers on there know that the work will be inconsistent? (Note: this is technically NOT a 1099— the person works for Upwork, and not you— we talk more about that here.)
    • Should you instead think about a W2 employee who is paid hourly? (This is what most retail shops, restaurants, and other shift-oriented businesses use.)

    Finally, another consideration you’ll want to throw in the mix is:

    Question 3: Does this person need to be in the office?

    What kind of employee are you hiring (i.e. marketing, sales, operations)? Does this person need to be on site working with the team, or can this person work from home?

    • If this person can work from home, a 1099 employee (or freelancer from a freelance website) may make more sense since you will want to “try it before you buy it”. Not everyone works well from home, despite their best wishes to do so, and we highly recommend any work from home role starts with a contract-to-hire situation (i.e. like a 30 or 60 day 1099 status).
    • If this person will be in the office, and the rest of the office staff are W2, it might make more sense to hire the person on as a W2 if the hours are consistent and you have the budget for a part time or full time salary, or as a W2 hourly employee.

    Now that your head is spinning with options, let’s look at how to hire a 1099 first, and then how to hire a W2 employee.

    Upwork is one of the major players in the freelance and 1099 talent pool space. According to Upwork’s 2016 report Freelancing in America, 79% of people on Upwork prefer freelancing as a 1099 to working as a full-time employee. Freelancers on Upwork average a workweek of 36 hours, and only 52 percent of them say they have enough work. In other words, it’s a big pool to fish in.

    So how do you find a great freelancer on there or somewhere else? Follow these 6 steps.

      1. Create a job description– We show you how to do that here. You’ll want to include that this is a 1099 position, and the estimated amount of hours or number of projects you need them for.
      2. Decide where to post it – We provide the top free job posting sites here, including freelancer websites. We also talk about 3 of the largest freelancer websites in our buyer’s guide.
      3. Phone screen your top candidates – We have a great free 5 minute and 30 minute phone screen template in our top 51 question phone screen interview guide.
      4. Sample assignment – Especially for a skilled contract employee, a sample project that is paid is a great way to see if they are a fit for your business (like a graphic designer). You’ll want to do something small, like a sample email marketing letter or a 1 week social media proposal, for around $100 to see what the person can do.
      5. Hire a 1099 – Once you find the right match, you’ll want to hire the 1099 contractor and specify what they are hired for (i.e. certain projects or estimated hours per week). You’ll also want to be careful about promising anything in the contract like a certain number of hours or a number of days- you want to make sure you have an “out” if you need to fire them. Include a termination clause in your contract with them, something like “Either party can terminate this contract with 10 days of notice”.

      Not sure how to write a contractor for a 1099? We recommend asking RocketLawyer.

      If you go through a freelancer website like Upwork, you won’t need to do any paperwork (just follow the system). If you hire them under your own company name, you’ll want to get a 1099 form from the contractor and record them into your payroll system.

    1. Onboard & train– Even though you hired a 1099, you need to welcome them onto the team and onboard them into the company culture. You’ll want to send an email introduction to the group about who they are and how they are working with the business, as well as get them onboarded in your email, IT, and other systems.

    There are some fields where freelancers and contractors are simply more common due to their on-demand or project-based nature. These fields include but are not limited to:

    • Graphic design
    • Social media management
    • Content writing or copywriting
    • Accounting
    • Recruiting

    Let’s now talk about how you would go about hiring a W2.

    If you’ve decided a part time or full time W2 employee is the right way to go, whether they are hourly or salaried, you’ll need to go through the following 7 steps:

    1. Create a job description – You’ll want to make sure that you include in the job description if this is a part time or full time position and that it is a W2 role (if you say that it’s salaried, that will be implied).
    2. Decide where to post it – Same as before, we provide 59 top free job posting sites.
    3. Phone screen your top candidates – Use our free 5 minute and 30 minute phone screen templates in our top 51 question phone screen interview guide.
    4. Consider an assessment – After you phone screen top candidates, send the ones you think you want to meet in person an assessment or questionnaire (instead of a paid assignment like with a 1099). This is an optional step that can help you to see the person’s writing and communication skills, as well as their commitment to the position.
    5. In-person interview – After the assessment or questionnaire, take your top 3-5 candidates and invite them in for an in-person interview in the office. We provide a guide on how to interview someone in 5 steps, as well as a great 120 question interview article that spans several kind of roles. Finally, you could also consider a structured interview, which is where you ask the same questions to every candidate (this lets you compare them apples to apples).
    6. Hire a W2 – Hooray, you’ve made the hire! Find our checklist on what steps you need to take for a personnel file in order to make this hire kosher on all levels.
    7. Onboard & train – With a W2 employee, employee onboarding is very important for the success of a hire. You’ll want to send an email introduction to the group about who they are, their role, and who they report to, as well as get them onboarded in your email, IT, and other systems. You’ll also need to set up a workspace for them.

    There are some fields where you’ll be hard-pressed to find a 1099 or freelancer, simply because they are usually full time roles that are out there. You may be able to find a 1099 from someone who is perhaps retired, but then you’ll pay a lot more too.

    The following fields, in general, are usually W2 roles:

    • Marketing roles
    • Account/Client Manager
    • Administrative Assistant or Office Manager
    • Operations roles
    • Any managerial or executive level position

    Let’s now talk about the advantages and disadvantages of each kind of employee.

    Employers and employees alike tend to have very strong opinions on if a W2 vs 1099 relationship is best for them and their team. Many people feel they would never try the other kind for reasons varying around the pros and cons we list above. What matters the most is having the correct paperwork and onboarding process for each kind, so that when the contract or employment relationship does eventually end, it’s without any liability to you as the business owner.

    gustAnd don’t forget to check out Gusto to make compliance easy regardless of what kind of employee you have. Click here for a free 30 day trial.

    Christy Hopkins, PHR, is a Human Resources consultant and writer at FitSmallBusiness.com. Her areas of expertise include full spectrum talent management (including recruiting & performance management), organizational change, and implementing HR systems. While being a part of FitSmallBusiness, Christy still maintains her HR consulting and recruiting firm that boasts over 30 small business clients spanning the U.S. from Vermont to Seattle.

    Thanks for this great article, couldn’t agree more. I also would like to share my opinion here. Outsourcing work to freelancers instead of hiring full-time employees is a great way to get things done in a cheaper and more flexible way. However, it comes with few limitations – lack of quality and commitment. If you go to freelancing sites to hire freelancers, the sites will cut a significant amount of money from the project. Also, they can suspend or cancel your project, often, without or for very silly reason, though it is solely business between you and the assistant. Also, there is no supervisor of the assistant, so you will have to monitor the activities of the VA. This is a problem when you don’t have enough time to supervise the VA and this may lead to quality compromise. Also, in most of the sites, the minimum wage rate is fixed(often high for the type of the job you want to get done) and therefore although the VA want to work on cheaper rate, you won’t be able to do so in most cases. Also, as almost all freelance VA works from home, they don’t have sufficient infrastructures like good internet connection and computer system and therefore works get hampered when emergency situations take place like power-cut. Another alternative is hiring virtual assistants from outsourcing companies.

    When you hire VAs from outsourcing companies, you will deal with the company owner and the VA will get your work done. As a result, although you will directly communicate and get work done by VA, you will not always have to monitor the quality of work since the company supervisor will ensure this for you. Also, there is no middleman between you and the company and you will always have the opportunity to negotiate. Only issue with the outsourcing company is finding the reliable and trustworthy company that provides the exact service that you need among thousands (many of them are just time wasters).

    When I started my food delivery website, I needed to upload nearly 100 restaurant menus. After considering all pros and cons of both freelancing sites and outsourcing companies, I decided to go for outsourcing style. So I was searching for low cost outsourcing companies. India is standing top in the rank of outsourcing industry. so I decided to try an outsourcing company from India. After hours of online research, I found a company called Staff India who directly provide virtual assistants. They provided me 5 VAs that I had to pay for this project and thus the project was completed fast. But I didn’t have to communicate with them all the time, I just communicated with the supervisor couples of times and he ensured the project goes smooth. I was very pleased with their service and since then I always get my projects done by them. So, my experience with outsourcing company is satisfactory.

    Thanks for dropping in and sharing your experience. So it sounds like for your situation, the best option wasn’t to hire freelancers, but to go through a staffing firm that would recruit & manage your VAs?

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