1099 Contractors vs. W-2 Employees: Classify Your Employees

In the United States, W-2 is the standard employee classification, while 1099 contractors are freelancers, contractors, and other short-term workers. Misclassifying a W-2 employee as a 1099 contractor carries heavy financial, legal, and sometimes even criminal penalties, but figuring out the difference between 1099 contractors and W-2 employees can be complicated.

In this guide, we break down the differences between these two employee classifications.

1099 Contractor vs. W-2 Employee

In the U.S, 1099 contractors They are independent contractors, freelancers, freelancers, or self-employed workers who are not considered employees of a company. They are called that because they receive a 1099 form at the end of the calendar year.

W-2 workers They are considered employees of a company and can be full or part-time. They are called that because they receive a W-2 form at the end of the year. The following chart summarizes the main differences between 1099 contractors and W-2 employees:

Why 1099 vs. W-2 Classification Matters

Misclassifying an employee as the wrong type carries heavy penalties in the US. Depending on the situation, employers may be required to pay some of the following expenses if they misclassify a W-2 worker as a 1099 contractor:

• Penalties for tax violations for unpaid Social Security, Medicare, FICA, and income taxes.
• Payment penalties of up to $1,000 per person for wage and labor violations, such as rights to benefits such as overtime pay and minimum wage.
• Unpaid unemployment insurance and workers' compensation premiums.
• Back wages and benefits during the misclassification period.
• Legal costs for disputes and class actions.

In addition to these financial penalties, misclassifying employees can seriously damage your company's reputation. Misclassified employees may leave the company entirely and warn other potential employees to stay away. If this happens, your company may struggle to attract top talent, which will have cascading effects throughout the business.

Examples of 1099 workers versus W-2 workers

Both 1099 and W-2 work can take many different forms. Below are some examples of both types of workers to further clarify the difference:

1099 workers

• A consultant who works on a project for a limited time.
• Freelance talent such as writers and photographers.
• Workers hired to complete a certain task or project.
• Subcontracted workers hired through a temporary agency.

W-2 workers

• Hourly employers who work in customer service jobs.
• Salaried employees working in an office.
• Executives and managers of an organization.

1099 contractor payment and taxes

How a 1099 Contractor Gets Paid

Typically, 1099 contractors are paid through billing. Invoices can be presented on a certain schedule (such as once a month) or at certain project milestones (such as upon completion). Payment terms may vary from payment upon receipt to 30 days and 60 days. Contractors can be paid by cash, check, or direct deposit. The best payroll software, like Gusto, makes it easy to pay 1,099 contractors and W-2 workers through the same platform, so you can keep everything centralized.

What taxes do 1099 contractors pay?

There are a couple of taxes that 1099 contractors must pay, starting with the total self-employment tax. The self-employment tax rate for 2024 is 15.3%, of which 12.4% will go to Social Security and 2.9% to Medicare. They must also pay federal income taxes, and the rate varies depending on income level. If 1099 contractors expect to owe more than $1,000 in taxes during the year, then they must pay quarterly estimated taxes. They may also be responsible for additional taxes, such as state income tax.

W-2 Employee Pay and Taxes

How a W-2 Employee Gets Paid

W-2 employees can earn a salary or an hourly wage and are paid during regular payroll calculations. Most companies have a bi-monthly or weekly payroll calendar, while some follow a weekly or monthly calendar. Most W-2 employees are paid by direct deposit, although some can be paid in cash or check if they request it. The employer withholds taxes from each of your paychecks; Payroll software like Gusto automates these calculations and deposits to reduce errors.

What taxes do W-2 employees pay?

Taxes are structured differently for W-2 employees, and payment is split between workers and employers. For each paycheck, 6.2% will be withheld for Social Security and 1.45% for Medicare, for a total of 7.65%. Employers then match that same amount, doubling the amount of taxes paid to 15.3%, but only half of that amount comes out of the employee's paycheck, unlike 1099 contractors. The appropriate amount of income tax Federal and state income will also be withheld from each paycheck, depending on the income group to which the employee belongs.

What type of worker should you hire?

Still not sure where you should hire a 1099 contractor or W-2 employee? You should consider hiring a 1099 worker if:

• You only need them for a short period of time, such as for a specific project or to cover maternity leave.
• You have a specific skills gap in your company that you need to temporarily fill, such as hiring an IT expert to help you with a software migration.
• It requires the worker to perform less than 30 hours of work per week.
• You don't care if the person works for other companies at the same time.
• You don't expect to control when, where, or how they do the work.

You should consider hiring a W-2 worker if:

• You need them to do more than 30 hours of work this week.
• You want to keep them on for a long time, perhaps indefinitely.
• It has an ongoing relationship with the worker and vice versa.
• Expect some level of control over how the employee works, such as requiring them to work certain hours or come to the office.
• The work they will do is fundamental and integral to the business.