As your business expands, you might need more help than your current capacity allows. When considering hiring additional support to scale your business, you’re typically faced with two choices: hiring 1099 contractors or W-2 employees. Each comes with distinct legal classifications and associated costs.
Understanding the advantages and drawbacks of 1099 contractors versus W-2 employees is crucial for solo business owners deciding how to grow their business most effectively.
1099 contractor vs. W-2 employee: Understanding the difference
Distinguishing between 1099 contractors and W-2 employees primarily focuses on your business’s control over the worker. This includes to behavioral control, financial control, and the relationship of the parties.
Employees are integrated into the company’s operations, with the employer dictating work schedules and methods. Independent contractors, however, maintain control over their work processes and often juggle multiple clients.
The terms 1099 and W-2 refer to the IRS tax form used when reporting earnings for tax purposes. You can find versions of the W-2 form, 1099-NEC, and 1099-Misc on the IRS website to compare.
In most cases, businesses withhold taxes and offer health and retirement benefits for W-2 employees, while 1099 contractors are responsible for their own taxes and providing their own health insurance and retirement plans.
Business owners must also adhere to state-specific laws governing the classification of workers in addition to federal regulations. The choice between hiring an employee or a contractor is crucial and can have an impact on long-term business strategy and growth. In short, employees are usually suited for ongoing, long-term roles and contractors for specialized, short-term projects.
Check out our complete guide comparing 1099 contractors and W-2 employees here.
The pros and cons of hiring a W-2 employee
While any hiring should be considered a significant decision when you’re self-employed, hiring a W-2 employee is a greater commitment. Here are the biggest pros and cons of hiring an employee.
Pros
Stability and commitment: Employees tend to be more committed and stable, offering long-term reliability. While some businesses hire seasonal employees, most businesses consider full-time employees as long-term investments.
Greater control: Employers have more control over employees’ work processes and schedules. Employees often have set working hours or schedules and follow procedures dictated by the business.
Team cohesion: Employees can more easily integrate into company culture and team dynamics. With the long-term nature and dedication of W-2 employment, employees are often more reliable team players.
Cons
Higher costs: W-2 workers often require additional costs like employee benefits, taxes, and insurance. For example, most businesses must have workers’ compensation insurance and contribute a percentage of the employee’s pay for payroll taxes, such as Social Security and Medicare withheld from employee paychecks.
Regulatory compliance: Employers must adhere to more extensive legal and tax regulations, such as following strict minimum wage guidelines. Employees have significant legal protections. If you’ve ever worked somewhere with those employer responsibility posters in the breakroom, you get the idea.
Less flexibility: Managing employees typically requires more structured environments and less operational flexibility. That may include more time invested by you as a manager and more planning for how they should do their work.
The pros and cons of hiring a 1099 independent contractor
Hiring a contractor comes with fewer commitments and more flexibility. Consider these pros and cons of choosing a 1099 contractor rather than an employee.
Pros
Flexibility: Contractors offer high flexibility to scale work up or down as needed. Contractors, such as freelancers, often work with multiple clients, so you’re often not relied on as a long-term, full-time income source.
Specialized skills: Your business can access specialized skills for specific projects without a long-term commitment. If you want help with a specific part of your business or for a temporary need, a contractor could be a perfect fit.
Cost-effective: Contactors can be more cost-effective as they handle their own income tax withholdings and benefits. They’re not included in company health insurance or retirement plans. You’ll typically pay per project or per hour with no additional financial commitment.
Cons
Less control: Businesses have limited control over how and when contractors complete their work. Depending on the arrangement, you may not have control over their work location, the tools or apps used, and exactly when they complete an assignment or task.
Lack of consistency: Contractors may not be as integrated with your team, affecting consistency. Shorter-term contracts may mean hiring and training more people than a single long-term employee.
Availability issues: Contractors have other clients and may not always be available or may need more time to complete a project than you’d prefer.
Deciding which is right for Your business
For a worker to be considered an independent contractor, they must be truly independent. If workers are misclassified as contractors when the work they perform is more like an employee, the small business can be penalized.
Misclassification may lead to high fines, payroll taxes plus penalties and interest on the unpaid payroll tax. Understanding the type of worker you’re hiring, even a part-time worker, requires due diligence beyond filing simple tax forms.
No two businesses are exactly the same, so it’s up to you as a solo business owner to decide whether a W-2 or 1099 worker makes the most sense for your business needs. Ask yourself the following questions to help guide your decision:
What is the nature and duration of the work?
Contractors are often best for short-term projects or specific needs for a small part of your business. Employees may be better if you need full-time help or a long-term commitment. The Department of Labor issues guidance on worker classification if you’re on the fence.
How much control do I need over the work process?
You may get the best results from an employee if you have particular preferences about which tools or software a worker uses. Contractors usually get the freedom to work however they choose if the result meets your standards.
What is my budget for this role?
While each has different financial commitments, considering your budget and business finances can help you make the best decision. Review your financial statements to ensure you can afford a new worker.
How important is team integration for this role?
If you need a dedicated person who works closely with others in your business, an employee could be better. If the worker can mostly remain independent, a contractor may be best.
Am I prepared to manage the legal and tax implications of an employee?
Hiring and managing employees requires a greater financial commitment and legal requirements. With contractors, your commitments generally end when they’re paid.
Bottom line: 1099 contractors vs. W-2 employees
Forms 1099 and W-2 are more than tax forms. As a solo business owner, the decision between hiring a 1099 contractor or a W-2 employee is pivotal to your business’s growth and strategy. Contractors offer flexibility and specialized skills for short-term projects, while employees provide stability, commitment, and integration into your team for long-term roles.
Weighing the pros and cons, such as financial implications, control over work processes, and legal responsibilities, is essential in making a choice that aligns with the nature of the work, your budget, and your business’s long-term goals. Whether you opt for the adaptability of a contractor or the dedication of an employee, your choice plays a crucial role in shaping the future of your business.
How Collective can help
Collective supports solo entrepreneurs who are the sole employee of their business and don’t plan to hire additional employees for at least six months. If you only hire contractors, Collective is standing by to help with your accounting and bookkeeping needs.
Eric Rosenberg is a finance, travel, and technology writer in Ventura, California. He is a former bank manager and corporate finance and accounting professional who left his day job in 2016 to take his online side hustle full-time. You can connect with him at Personal Profitability or EricRosenberg.com.