1099 vs. W-2: How Independent Contractors and Employees Differ

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In this economy, many businesses are trying to cut back on full-time staffers by hiring contractors to do the same work instead—minus the expensive benefits.

As a result, it can often be difficult to tell employees and contractors apart. But there are significant differences, both in terms of workers’ personal bottom lines and in the eyes of the I.R.S.

To better understand the nuances between the two designations—and what to do if you think you’re being misclassified—we talked to Jaime Campbell, a CPA with 10-plus years of experience.

1099s and W-2s: Breaking Down the Difference

Simply put, 1099s and W-2s are two separate tax forms for two different types of workers. If you’re an independent contractor, you get a 1099 form. If you’re an employee, you receive a W-2.

As a W-2 employee, payroll taxes are automatically deducted from your paycheck and then paid to the government through your employer. If you’re a contractor, you are responsible for calculating your own payroll taxes and then submitting the sum to the government on a quarterly basis.

RELATED: 10 Tax Filing Mistakes to Avoid

Since contractors may not always be vigilant about paying their taxes, the I.R.S. has been cracking down on this group of workers for the past three years. In fact, the government has collected $9.5 million in back wages from employers who misclassified workers as independent contractors since 2011.

How to Determine the Correct Job Status

When it comes to who should be classified as an employee and who should be considered an independent contractor, Campbell says that the key word is “control.” In other words, “it’s all about who controls the work you do,” she says.

Navigate Your Taxes

  • liz

    This article excludes a huge number of employees who are contracting through agencies on site for a long duration. I am paid on a W-2 by a staffing agency which means I have no job security, no benefits, and still can’t deduct most things. I have little control over my hours and work on site at one company until they decide they don’t need me any more. As far as I can tell, it’s the worst of all worlds, but my industry is going more and more that way. The worst is that I have no 401K option and the health insurance is both crappy and $450/month for just me.

    • ranavain

      Well, it doesn’t technically exclude you. You are a W-2 employee of the staffing agency. I think the article does go overboard in describing the benefits of W-2 employment; after all, most W-2 employees at McDonald’s don’t have benefits either, and they don’t have job security.

      But those aren’t the main hallmarks of being a W-2 employee. They don’t even mention the biggest one; that as a W-2, your employer pays half of your Social Security tax, as well as withholding other taxes on your behalf, AND when you’re a 1099 contractor, you end up with a big tax liability after your first year if you don’t know what you’re doing (and in my experience, most don’t). When you are self employed, you have to pay your own employee taxes as well as your own employer taxes.

      • liz

        But my point is that it sort of assumes that those of us who are “employees” get benefits, which I don’t. And, I’m treated as a contractor where I actually work (which is not at the staffing agency). So, yes, technically I’m an employee of the staffing agency, where I work I’m treated as a second class citizen and I’m ineligible for all the benefits. My office calls me a contractor.

        • AnaPascal

          I’m with you Liz – a contractor who works for/at a different company. I like because I’m making good money, but I HATE feeling like a second-class citizen. I also hate not having real vacation or sick time. I spent all winter hoping I wouldn’t get sick – because if I’m not at the office, I don’t get paid. Same for holidays like Memorial Day. The office is closed, so I make less money. It’s a bummer in that sense. Requires careful budgeting.

          • L Sando

            The other thing that is not great about being a contractor is when a project is canceled and you are unexpectedly out of work. I had a proposal project canceled in the middle. I ended up with much less money that year but still as a W2 paid high taxes on little income. Our tax structure is criminal right now.

        • Chris Hill

          This was my case when I worked at a Military Hospital. I wasn’t a government employee, so I didn’t enjoy all the benefits of being a government employee. However, I was a W2 employee of the staffing firm that held my contract, and DID enjoy the benefits of being an employee of that firm (which were better than those of a government employee). That included 401K match, health insurance (until the ACA screwed that up), vacation, etc., etc. The only difference was that I didn’t actually work at the firm, I worked at another location. It’s the same as if say, you work for Geeks On Call, and they send you to Bob’s Factory to install a server. You don’t work for Bob’s Factory, you work AT Bob’s Factory doing work FOR Geeks On Call. So, of course you aren’t going to get compensated from Bob’s. Bob’s pays Geeks On Call, then Geeks On Call pays you. When you’re a W2 contractor on a long-term contract, you most likely have a permanent seat AT the target location. But at the end of the day, it’s the same scenario. Your work location pays your firm to have work completed, and your firm hires you to do the work.

          • L Sando

            I seriously doubt you were a contractor with better benefits than a federal employee. I have family who are federal employees and no contractors I have ever met got better benefits.

  • Brianne Archer

    Articles that tell workers that they should be classified as a W-2 employee instead of a contractor are all well and good, but we can’t necessarily change anything. I used to get a W-2 from my side job but my employer decided to start giving me a 1099 and no raise to compensate for self-employment tax. It sucks, but I still need the money so I can’t quit.

  • Hifi1

    There is a 3rd option to the company releasing control or reclassifying you as an employee. Make a big deal about it, and they simply fire you.

  • tammy

    my son has worked for his company for almost 2 yrs now all of a sudden they decide he will now be a independent contractor can they do this they are taking his earned 1 wk vacation away from him seriously can they do this

    • Sir-Dashing

      i’d speak to a labor lawyer about that. even if they fired him they would still have to pay him his vacation days.

      • Eldridge L

        No actually they don’t. The only thing that the labor department cares about is payment for actual work or that should have been paid for actual work. Vacation is a specific exclusion. Even if there is a pre-employment contract, the DoL does not regulate vacation pay. That would have to happen at the state level for a breach of contract with an attorney, but it would not affect either the Feds or the State with respect to enforcement. I will say, this in defense to what you were saying…IF a state has its OWN laws regulating vacation pay, then that certainly trumps this. But the IRS does not regulate vacation level, and not every state has this provision…most don’t…so it just depends on where someone is located…but it cannot be held under a blanket statement that they “have” to pay for unused vacation…it just depends on the state where the employee is working…

  • Rene

    I bet the same people that complain here are the same people that complain about how evil Unions are. I have heard so many people over the years downing on Unions but now now America is waking up to being abused by these big corporations and realizing they have no retribution.

  • don

    i drive a shuttle bus for a company on weekends.i do this as a part-time job.i was just notified that starting this year i am now a contract worker.i use their vehicles to transport all customers.this doesnt sound right.does anyone know if this is right?

    • curious123

      Don- What company do you work for? No- this does NOT sound right at all. What if you hurt yourself on the job!?!?

  • JC Callender

    I own a small landscape company and had only 1 employee last year and hope to have between 2-5 this year, and will probably pay them as Independent Contractors as the administrative cost to issue checks would take away from the employees pay. Once I get over 4 or 5 employees, I’ll probably start W2′s, I just want my employees to get the most I can pay them.

    • ashley

      JC – I stumbled across this website looking for some info to help one of my clients who is trying to persuade his 1099 contractors to become 1099 (stability, tax compliance, time-off, etc). I set up payroll for small business owners like yourself, seasonal and year-round, for as few as 1-2 employees. Let me know if you want to talk about these administrative costs – chances are they’re much less than you think! ashley.m.griffin@adp.com

      • JC Callender

        Thanks Ashley, I’ll keep you in mind.

        • Dang

          I dont know if this right.. This is y first time to work in.i have a green card holder,and my boss is a filipina…first I ont know the policy.here in u.s…so she gave me an agreement..when I was worked their in my 1st season,she said that myMONTHly salary is $1000 cash and $1000 cheque means cheque are those deduction for my benefits,and free ticket back an forth..but my time 12hrs every 6x a week.but for me thats fine as long are they kind..my 2nd season they increased my salary maybe because they know how im a how im a hard worker,trustworthy,loyal,helpful etc..$1000 cash $2000 cheque…i work 12-14 hrs…i wake , I treat them my family .i sleep 11pm or sometimes2am because of them and to my work….after my season ,my boss doesnt gave my free ticket,and she did not to inform me before the seasons end.of course everybody knows that we should book early so that we can find cheap ticket,she told me that day the end of mu seasonthat she cannot afford to buy my ticket.

    • Eldridge L

      It depends on whether you have control over what they do and whether you provide them the tools/resources to do their jobs. If you are providing rules/regulations/policy etc and/or providing the means for them to do their jobs, then they are W-2 employees, regardless of whether you have 1 or 1000 of them. If you are wanting to find an alternative, then may I suggest using an employee leasing company who can take that burden off of you.

  • tekctrl

    “Then the company will generally have two options: Either they’ll have to release control, increasing your freedom over your work and schedule, or they’ll have to reclassify you as an employee and start providing you with the benefits, tools and infrastructure due to employees.” Nope. The author missed another very popular option used by employers. They can terminate you. Under ‘at will’ employment, they don’t need a reason beyond ‘we feel like it’.

    • Eldridge L

      That is true within some boundaries though. It is an at-will employment, and you are right that they missed that option. I thought about that myself. But, the only standard that has to be applied is that if they provide a reason, the same standard must be applied to everyone who falls in the same category. Meaning, if they fire one for wearing a blue tie, they must fire everyone who is wearing a blue tie. Where employers really mess up is in giving a reason in the first place. Even if there the employee has been with the company for 10 years, the best bet for the employer is to just say “this isn’t working out, so good luck” and leave it at that. Once they give a reason, though, there is a greater burden of proof. If they cite something like poor job performance then there has to be a documented history of it to really hold up in court. Most employers really goof up, even though they are at-will, in giving an explanation…

  • scott_lewis

    Be very careful if your company wants to convert you from a W-2 employee to a 1099. Often, companies that are in trouble will do this. If you’re 1099 and get let go, you dont’ get unemployment insurance benefits which you receive if you’re a W-2 employee.

    Also, many states require that you get paid for any unused vacation when you leave a company or are converted to 1099.

    Personally, I left W-2 employment to go 1099 full time because I can make a lot more money even after the additional taxes. This isn’t always the case, though.

    • s dubbya

      I guess it depends on whether you value the income more than the benefits. Benefits are just another way for employers to pay less.

  • Christina Coleman

    Aplanbforme.com Do something that makes sense!

  • miked

    Does a small 1-man business run the risk of trouble with the
    IRS in the following scenario? This
    1-man business has not had the need or the stable revenues to support W-2
    employees, so the business has paid a couple of people as 1099 contractors when
    some help was needed. In the middle of
    the year, the business need for permanent employees and revenue level rose to a
    point where hiring W-2 employees was necessary and possible. The business then hired the two 1099
    contractors as full-time W-2 employees. Obviously,
    the result is two people that had income reported on a 1099 and a W-2 in the
    same year. I discussed this scenario with a local accountant and she was
    adamant that this was not something that should be done. Your thoughts?

    • Eldridge L

      It still goes to control, Mike. If their duties require them to follow certain regulations that you set into place where you set the boundaries (dress code, working hours, etc) and/or if you provide them with the tools to perform their jobs (physical tools, computer equipment/software…even MS Office), then they are W-2 employees. There is another alternative, though…that is an employee leasing company…they are specifically tailored to helping businesses with fewer than 50 employees and can take away a lot of the burden with this…

      • miked

        Thanks very much for the reply and the good information. What I really curious about is if the employer decides to hire a 1099 contractor as a full-time W-2 employee, does the employer run into trouble with the IRS for paying a person by 1099 and W-2 for the same year?

        • Eldridge L

          Mike, first my apologies for being behind in answering. Was out of pocket for 2 months.

          I do not see the problem with this in that there are situations, particularly with startup businesses, where someone might come in as a consultant first and then sign on as an employee. For the contractor portion where no taxes are filed on behalf of the individual, then 1099 is acceptable. Once the business is in operations, assuming they decide to come in as an employee, then you switch to W2 based on the control I mentioned. I have done this many times including my most recent job. I started as a contractor to do some computer programming and was paid according to my hours, but I was free to engage in other activities and met the criterion of contractor. Once the project was complete, the owner offered me a full-time salaried position. That year I had both 1099 and W2 because of the time in which I was paid for both. I am currently about to do the same thing with a friend of mine next year. I am helping him set up a restaurant from the ground level and will be working as a contractor for the first few months until the company begins operations. If, at that time, he wishes for me to remain on full-time, I will go on a salaried position that he would then pay my portion of MEDI and FICA plus Unemployment. For the first 3 months minimum, I will be a contracted position where I will have nothing paid on my behalf and will be fully responsible for all taxes. I will fit the criteria of a contractor during that time and will be able to freely set my own hours, supply my own supplies, and engage with other companies if they do not violate the NDA that I’ll have in force. The control would shift upon full-time employment. Next year, I will have both 1099 and W2. I have had this many times over the past 25 years. It is perfectly acceptable, unless there is some weird rule that I’m not aware of that has changed recently. It goes to control at the time that the payments are being made and the circumstances under which they are made. If your friends are acting in the capacity as contractors and fit the control/supply criteria at that time, they qualify only for 1099s. If circumstances change that allow them to come in as employees as defined by the control/supply test, they would get the W2s for that portion of time. I really do not see a problem with this, unless there is something else that I am missing.

  • Daren

    At the end of the day, we (employers) don’t have the luxury of deciding if we want to treat a worker as a independent contractor or employee. That is determined by the IRS. They set out very specific criteria which defines the relationship. In other words, if someone fits the profile of a full time employee, but an employer want to call them a 1099 contractor just for convenience, it really doesn’t fly, and the employer is still liable for employee type expenses. I recommend searching how the IRS defines this criteria, and complying.

    • mark

      What do you mean “don’t have the luxury of deciding” ?

      The criteria is clear – as stated in the article – the degree of freedom and control.

  • Lauren

    I am a massage therapist working in Virginia as a IC. I strongly feel that we should be employees as we have specific job training requirements, uniforms, mandatory meetings and strict rules which have specific repercussions if not followed. What recourse do I have to alter this situatuon?

  • Apaint

    Ok got one of my questions answered on an employee with both 1099 income and then hired by us now has w-2 income….this works.

    Now BIGGER PROBLEM….at the same time that my husband hired the above 1099 contractor as a full time employee, he decided to use a payroll company. He put himself and the new employee on the payroll. Ok for the employee, but for my husband as self employed, it is not working out well while I am doing the taxes.

    Because I enter the information from his W-2 first, then all the company 1099 information next, it is combing the 2 for our total income. Which is obviously not the case. The amount on his w-2 comes out of the total of the 1099′s. But since it is combining the two types, it now says we are too high of income to receive Child Tax Credit.

    As well as much of the money from the 1099′s goes to other guys salary.

    I am guessing that down the road in the tax return, that I will get credit for the expenses paid to the employee’s salary plus what my husband has paid himself through the payroll company. But that will be too late for the Child Tax Credit.

    Should he have not used the payroll company for himself? What other help can you offer?

  • Dan Marrin

    Thank you for this information. I was a 1099 employee at a documentary company, where I worked steady hours 2-3 days a week. The days would change if I had other gigs going on during the week, but I worked every week for nearly a year. I thought I should have been a W-2 after a while, but I think now I can get how I would have been thought of as a W-2 given my flexibility to change the schedule.