Payroll can be a major burden for many small businesses. The trend lately seems to be that companies are letting the W2 employees go and opting instead to contract out to 1099 employees. In the past ten years alone the number of businesses transitioning to independent contractors over full-time employees has risen by just over forty percent. The question thus stands, does it make sense for your business to explore the idea of using 1099 employees instead of W2 employees. Below we outline the pros and cons of each.
What Is a W2 Employee?
Essentially a W2 employee is someone hired on full-time and someone who is put on your payroll. According to the IRS, a W2 employee is directed by you, meaning you control the work that is to be done and consequently how that work shall be done. From a tax standpoint, you withhold a W2 employee's income tax, social security and Medicare taxes. You must also pay workers comp on that employee. And come tax time, you need to report their wages to the IRS. There is a lot of money involved with hiring a W2 employee—make no mistake about it. Not to mention a bit more paperwork than you'll have if using a contractor.
What Is a 1099 Employee?
Technically someone who receives a 1099 form isn't considered an employee, rather they are an independent contractor. To this end, you cannot direct how the work is done. You do of course have control over the results of that work upon it being delivered to you, but not the process of the work itself.
An independent contractor is their own business. You don't withhold their taxes—they are responsible for reporting to the IRS and taking care of their income taxes. To do this, you will send them a 1099 form to enable them to report any income they make as a result of working with your company.
1099 or W2 Employee: Which is Better?
When you're talking about a full-time W2 employee, you as the business owner are in charge. In other words, you determine when they work, how the work is conducted, and what work specifically they will be performing. You also determine what they will be paid as a result of their efforts. So this person, for instance, will likely work on-site, in your office. They'll probably have a specific time they're required to report to work. And they will continue to work for you in an ongoing capacity.
On the flip side, an independent contractor calls their shots. They will tell you what they expect to get paid and you can agree and/or negotiate with them. They will also dictate how and when they perform the tasks required. Their responsibility to you rests in the results. They need to deliver what you agreed upon going into the arrangement. You're relying on them as a separate company to get the job done because they have expertise in a certain field or area. As soon as they've completed whatever the project is, your working relationship is over unless of course, you want to hire them for something else.
Unlike your full-time employees, the 1099 contractor will take care of their insurances and taxes. And you usually do not have to pay workers comp on them.
Benefits of Using W2 Employees
So what are the benefits of going the full-time employee route…For one, they're working directly for you. You have more control over how the job gets done. Not to mention, their loyalty is with you. Whereas if using a 1099 employee, you may not be the only person/company with whom they're engaged, thus their focus may be a bit more scattered. Also, keep in mind with a W2 employee, you can move them around within the office; that is to say, if you need another type of job done, you have the flexibility of assigning that employee to it. An independent contractor, however, will generally only focus on one specific task.
Benefits of Using Independent Contractors
With an independent contractor, there is less involved as far as commitment. Once the project on which you're working together is complete the relationship is over. You can rehire them or opt to try someone else. So there's that element of flexibility. Also, usually independent contractors do have expertise in one area—this may not be the case with an employee.
From a time and money standpoint, there's much less paperwork involved, plus you're not having to pay their insurance and benefits. 1099 workers do tend to be more affordable in some respects.
Understanding Workers Comp
Many wonder if a 1099 employee requires workers compensation. This will be dependent on the state in which you're working. Certain states do require workers comp across the board—for both employees and 1099 contractors. Others will not require this. There are also specific industries in which it may be required regardless of employee status. Construction for instance usually does require workers comp for everyone involved in a project. Checking with the department of labor should let you know who requires what.
Paying Your 1099 Employees
Before working for you, a full-time employee will fill out what is called a W-4 Form. This will have their social and/or tax ID number. Similarly, an independent contractor fills out a W-9 form. This will also contain their social or tax ID number. How you pay them and when is up to you. Generally, the two of you will agree upon terms before a job starting. You do not withhold taxes from a 1099 employee. If you end up paying that contractor more than $600 for the year, you need to report this to the IRS via form 1099.
Regardless of which type of employee you opt to go with, you need to make sure that from a monetary and practical standpoint, it works for your small business. Working with contractors can be a way to cut down on costs while still getting a qualified professional to take care of the job you need to be done.
Here at First Union, we offer many loan options to help your business. We want to see your business be successful. Call today to speak to one of our advisers!