Understanding the differences between 1099 vs. W2 workers is vitally important for businesses that want to remain compliant with all regulations and tax laws.
By the Editorial Team at Roll by ADP on January 20, 2023
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You’ve done the hard work of drafting a business plan, securing funding, and getting your company off the ground — congrats! While you’ve gotten over the biggest hump of starting a business, there are still lots of moving parts to your organization that need tending to. And if you’ve expanded to the point of hiring employees, payroll might be one of the most complicated aspects of your business right now.
While the many facets of payroll might seem overwhelming, don’t panic! Roll by ADP offers small business owners an innovative payroll app that streamlines the process from start to finish. Featuring an easy-to-use conversational interface that makes payroll simple, you can now pay all of your employees in under a minute — no matter where you are or what device you’re on.
Concerned about navigating the different processes unique to independent contractors? Roll can handle that too. Our contractor payroll services make it easy to onboard and pay contractor workers with just a few clicks. Using the chat function, simply enter “Hire employee,” classify them as an independent contractor, and you’ll be guided step-by-step through the process — no training or boring video tutorials required! Just answer a few quick questions and we’ll do the rest.
While our platform will handle calculating, deducting and paying taxes for you, you may be curious about these pay structures for different types of employees. We agree that business owners should have a deep understanding of the nuances between 1099 vs. W2 workers. That’s why we’ve created this handy guide with everything you need to know.
Keep reading for an in-depth comparison of each, their pay structures, and real-life examples.
A W2 employee is what most businesses regard as the most traditional form of employment. This employee is paid from the business's payroll, and the company dictates the terms of the employment, such as hours and days worked.
The employer fills out the W2 IRS form for any employee who earned over $600 during that year. That form is then filed with the Social Security Administration.
The W2 form includes all wages paid to the employee, including tips and other forms of compensation. It also consists of the total amount of taxes withheld for local, federal, and state requirements. Social Security and Medicare taxes that were withheld are also included on the W2.
A copy of each W2 must then be distributed to each employee. This can be done via hard copies mailed to the employee or through digital distribution. Some companies use both methods.
Employees then use the W2 form to calculate their personal tax returns.
A 1099 employee is technically not an employee but is considered an independent contractor by the IRS. This means that, unlike a W2 employee, the business does not dictate certain terms of work for this particular worker.
A 1099 is filled out by the business and then distributed to both the contractor and the IRS at the end of the year. The 1099 will contain a total of all money paid to the contractor during that period.
A 1099 does not include any withholdings since the business is not required to calculate or withhold any local, state, or federal taxes. The company is also not responsible for withholding Social Security or Medicare taxes.
Another important distinction is that businesses are not responsible for unemployment insurance with 1099 independent contractors. However, certain emergency situations can sometimes allow 1099 workers to file for unemployment benefits, such as with the recent pandemic relief efforts.
A 1099 is for independent contractors, indicating self-employment income with no taxes withheld. A W-2 is for employees, showing wages with taxes withheld by the employer. The key distinction lies in employment status and tax responsibilities. Independent contractors manage their own taxes, while employees have taxes automatically deducted by their employers.
Instead, the IRS directs businesses to look at the totality of the business's relationship with the worker. Then, using a series of determining questions, the company should decide based on how those questions are answered.
This process should be relatively straightforward for most workers, and there isn't much ambiguity. However, it can be difficult for businesses to make a correct distinction for a percentage of workers who straddle both categories. How the IRS determines W2 vs. 1099 for each worker is based on the following factors.
This aspect looks at the business's amount of control over the worker’s employment. Does the company dictate the hours and days worked? Does the business control where the work is performed? For example, being in an office during regular hours. More often than not, W2 employees are given more instruction on when and where to work, along with the tools they use.
A contractor is generally free to work on their own schedule as long as tasks are completed.
This category looks at the worker's job or expenses related to those tasks controlled by the business. An example would be whether certain equipment required for the job is provided for the worker. This can be computers, tools, or manufacturing equipment. If the employer supplies these, it leans towards that worker being a W2 employee. This area also covers whether expenses incurred by the worker are reimbursed or not.
Finally, there is the type of relationship between the worker and the business. This area will deal with whether there are contracts between the two parties. It will also deal with other benefits, such as health insurance or retirement benefits like a 401(k) plan.
It’s also imperative to look at how central the tasks performed by the worker are to the main operations of a business. For example, if a business's core operation is to repair cars, then workers directly repairing those cars could be considered a company's core operation. This will further classify them as employees if the other factors above do not give a clear indication.
This may sound a bit vague, but due to the rise of "gig economy" type jobs, these debates have become front and center for many large businesses. Many states and the federal government are currently looking at these exact questions and how they relate to whether or not independent contractors are being properly classified.
Once you have determined whether a worker is a W2 employee or a 1099 contractor, there are some differences in how those workers are paid or otherwise compensated.
A W2 employee is paid via the business's payroll. The frequency is determined by the contract or agreement between both parties and is usually weekly or bi-weekly.
The company withholds specific payroll taxes, which are determined by the W4 IRS tax form filled out by the employee when they begin working. This document informs the business what deductions to make based on the employee's current situation.
A 1099 contractor is paid differently. The payment schedule does not have to be at designated intervals, such as weekly or bi-weekly, although it can be. The payment can be made after a project is completed or at certain milestones.
There is no set timetable to pay 1099 workers, and each relationship can have its own schedule.
Also, 1099 workers will receive direct payments from the business, which will not go through the payroll process of deducting withholdings. No withholdings are held from 1099 employees, and the tax responsibility is solely on the worker. This is a critical difference between 1099 and W2 employees.
However, several 1099 forms can be administered, depending on what method is used and how much is being paid. This is another difference between W2 and 1099 employees.
This IRS 1099 form may be used for freelancers or small businesses who receive direct payments via credit card from clients. It also covers any payments received through online platforms such as Paypal, Cash App, and others.
This is the IRS 1099 form that most businesses are familiar with and is used as a "catch-all'' for those contractors or payments that don't fall into specific categories for other 1099 forms. However, this form is being phased out and replaced with the 1099-NEC, discussed below.
To deal with the emerging gig-economy workforce, the IRS has rolled out a new form labeled the 1099-NEC. This is for all freelancers or so-called "side gigs" with earnings of over $600 in one year. This form replaces the 1099-MISC form for freelancers and other contract workers starting in 2022.
Different circumstances often call for different types of relationships with various skilled workers.
For example, let's assume a business runs a call center to field customer calls. That business needs more operators to work a regular shift, 5-days a week. In that case, running a call center is the company's primary business function. They also require that workers be at their location to perform their job during a specified set of hours each week. Finally, the operators all use the phones and computer systems provided by the business. So, in this case, those new operators would be W2 employees.
Upon hiring them, the company would collect W4 forms from each new hire to calculate their withholdings from each paycheck.
Looking at a different example to demonstrate when to use W2 forms vs. 1099 forms. Let's assume that the same call center business needs a new computer system installed. In this case, they may hire independent contractors who have the necessary skills but are only needed during the installation.
In this case, the workers can be 1099 contractors as they are not performing a key business operation. They are also not required to work specific hours. Finally, they generally use their own tools and equipment to complete the installation.
One interesting note is that in some instances, a worker can be both a 1099 and a W2 employee. For example, if a W2 worker also runs a side business and is hired to do contract work by the company the worker is employed at, that worker can be both a W2 employee and a contractor for different tasks.
Knowing how to hire employees and setting up payroll for a small business is crucial for businesses of any size. But Roll by ADP makes a complicated process simple. Here’s how it works:
Yep, you read that right — that’s it! Our innovative payroll app for small business allows you to pay all of your employees anywhere, any time. We automate humdrum administrative tasks associated with paying employees, whether they’re full-time or on a contract. Our chat interface also makes it easy to get answers to common payroll questions, address challenges unique to your business, and make sure your payments are accurate and on time.
Whether you’re running a small business with just a handful of employees or a large company with hundreds, Roll can make managing your payroll easier, faster, and more cost-effective. Download the app today to start your free 3-month trial to find out how Roll can make payroll effortless!