An independent contractor, also called a 1099 worker, is a person who has been hired to do a specific task or fill a specific role. 1099 workers are self-employed, which means they probably set their own hours, may work for more than one business, and if you're a business owner, you have little control over how they do their job. An example of an independent contractor is an electrician that a general contractor hires to wire a home for one specific task.
Since an independent contractor is self-employed, their payroll taxes are not withheld from their paychecks. They are responsible for paying their own taxes. When the IRS tries to decide whether a worker is an independent contractor, they look at the degree of control the business has over the individual, whether there's a contract and other aspects of the relationship.
You'll receive a 1099 form at tax time if you're an independent contractor. This form tracks your income. If you worked for several different businesses or organizations, you may receive several 1099 forms.
A W-2 worker is someone who is hired under an employment agreement. Businesses withhold taxes from their wages, pay employment taxes for them, and may provide benefits. Businesses train their employees and can exercise more control over employees than over independent contractors.
At tax time, these workers receive a W-2 form that is used to report their income to the IRS. An example of an employee is a person who works full-time in an office, receives training from their employer, uses materials provided by the employer, and receives paid benefits.
If you're an employer, you must supply your employees with everything they need to do their job. Employees cost businesses more money and require a lot of management that independent contractors do not require, but there are benefits.
Employees have company loyalty and may work for one company for a long time. They provide ongoing support to businesses, and because businesses can exercise control over their employees, they can set hours, control quality, and so on.
There are specific guidelines that the IRS provides to help businesses classify their workers. There are three dimensions that the IRS lists to help with classification:
Behavioral: The more control your business exercises over how the worker does the job, including which methods and tools they use, the more likely it is they are an employee.
Financial: Does your company control how the worker is paid? Does your company control whether a worker can seek other work from similar businesses? If so, then this may be an employee.
Relationship: Worker benefits like insurance and position permanence are extended to employees, not independent contractors.
It's important to remember that just because a contract exists between a business and a worker stating that the worker is an independent contractor, the IRS will still consider other aspects of the relationship to determine whether a worker is an employee.
When you're trying to decide whether you should employ an independent contractor or a W-2 worker, it's important to consider the needs of your organization and the guidelines the IRS provides to classify workers. Some businesses will hire both, for separate types of tasks. Asking yourself questions like those below will help you categorize your workers.
When deciding whether to hire 1099 vs. W-2 employees, it's important to follow IRS guidelines and ask yourself what your business needs. It's not enough to say that a person is an independent contractor - they must also demonstrate the characteristics of an independent contractor as established by the IRS. Contact Exact Payroll for expert assistance in managing your payroll and tax obligations for 1099 and W-2 employees.