1099 employees — Hiring independent contractors in the US and understanding the key differences between employees

While your parents and grandparents may have worked for the same company for decades, today many workers are embracing a much more flexible career path—self-employment. While working as a W-2 employee has its perks (stability and benefits), many 1099 workers enjoy the flexibility that working as a contractor offers. McKinsey found that as of 2022, the US workforce is made up of 61% W-2 employees and 36% independent contractors. The same report also revealed that the number of independent contractors rose from 27% in 2016.

So, what is a 1099 employee? A 1099 employee is an independent contractor who provides services to a business but is not considered an employee. Independent contractors receive a 1099 form instead of a W-2 for tax purposes. This means they are responsible for handling their own taxes and typically do not receive employee benefits.

Understanding the difference between how to manage W-2 and 1099 employees can help ensure everyone on your team is properly looked after and that you are complying with relevant employment and tax laws. What are the rules for 1099 employees? Read on to find out.

What is a 1099 employee?

Many people associate 1099 employees with “freelancers” and tend to picture creative types like writers, photographers, and graphic designers. However, more workers than most people realize are classified this way. A lot of doctors and dentists work as 1099 employees. As do lawyers, auctioneers, public stenographers, accountants, and many other professionals.

Basically, a 1099 employee is shorthand for “contractor.” Typically, a worker is classified as an independent contractor if the person paying them controls only the outcome of the work, not the specific tasks or methods the worker uses to achieve the end result.

Pros and cons of hiring 1099 Employees

As an employer, you need to think carefully about whether or not hiring a 1099 over a W-2 employee is the right move for your business. These are some advantages and disadvantages of doing so worth keeping top of mind:

Pros

• Less expensive. Because contractors don’t receive benefits like health insurance, retirement plans, or paid time off, you can save a lot of money by hiring a 1099 employee.

• Reduced overhead and logistics. You also have lower administrative costs since payroll taxes, workers' compensation, and unemployment insurance aren’t required.

• Flexible. Instead of making a major commitment by hiring a long-term full-time employee, you can choose to hire a 1099 worker on a project basis or as needed, without making any long-term commitments to them.

• Specialized skills. By being open to hiring a 1099 employee, you widen your talent search pool greatly and can find a contractor who specializes in specific tasks or has niche industry knowledge.

• Scalable. As your business grows, you may find it easier to scale your workforce up or down with the help of 1099 workers as your business needs change.

Cons

• Less control. You have a limited ability to dictate how and when work is completed as contractors set their schedules and many prefer to work remotely or follow their own workflow processes.

• Greater legal risks. The misclassification of employees as a contractor can lead to penalties and back taxes.

• Inconsistent availability. Unlike a W-2 employee who you can count on for 40 hours a week, contractors may have multiple clients. This balancing act can lead to potential availability conflicts.

• Lack of loyalty. Contractors may be less invested in the company’s growth than a W-2 employee whose financial future depends on the ongoing success of the company.

How to hire independent contractors

The most important thing to keep top of mind when hiring an independent contractor is to ensure they aren’t treated as an employee and are instead recognized properly as being independent. This can help you avoid running into a lot of legal and tax trouble down the road. Here are some tips for hiring an independent contractor successfully:

• Define clear terms. You will need a legal contract that specifies the scope of work, payment terms, and deadlines. The company should not control how, when, or where the contractor performs their work, only the final outcome.

• Inform the contractor of their responsibilities. To make sure both parties are on the same page, double-check that your 1099 workers understand what that classification entails. Specifically, that they will be responsible for their own taxes, equipment, and insurance.

• Review relevance regulations. Companies must comply with federal, state, and local regulations regarding contractor classification to avoid legal issues like misclassification.

1099 contractor vs W-2 employees

When debating between hiring a 1099 contractor vs W-2 employee, it can be helpful to first review the key differences between these classifications.

• 1099. These independent contractors work for a company but maintain control over how and when they perform their tasks. They are responsible for their own taxes, including self-employment taxes, and do not receive benefits such as health insurance or paid time off. Companies issue a 1099 form to report payments made to them.

• W-2. Considered a traditional employee, a W-2 employee is subject to the company’s control over work schedules, methods, and tasks. The employer withholds income taxes, Social Security, and Medicare taxes from their pay and often provides a standard suite of benefits like healthcare, a 401(k), and paid time off. W-2 employees receive a W-2 form at the end of the year to report wages.

How pay, benefits, and taxes work for contractors

Again—it’s a good idea to familiarize yourself with what being an independent contractor entails so you can provide the right support to your independent contractors. This is how pay, benefits, and taxes work when someone is self-employed.

• Payment methods. Contractors receive full payment directly from the company without any tax withholdings occurring. How they receive payment depends on the company but is typically done via ACH transfer, direct deposit, check, or via an electronic payment platform like PayPal.

• Benefits. When someone is self-employed, they are on the hook for securing their own health insurance benefits (this can be done through an insurer privately or can be achieved by working with their state’s health insurance marketplace), budgeting to take time off work, and managing the retirement savings process.

• Taxes. Employers do not withhold income, Social Security, or Medicare taxes for 1099 employees, which means contract workers are responsible for paying their own self-employment taxes and income taxes.

Tools and software for managing independent contractors

Managing 1099 employees is different from W-2 employees. To help simplify things, you may find that payroll processing software like Gusto or QuickBooks can make it easier to manage payments and tax form generation.

While you won’t be legally required to provide your 1099 contractors with healthcare access, if this is something you can afford to do, you can build loyalty amongst your 1099 workers. For example, you may want to provide them with a healthcare stipend. Thatch is happy to help you find a healthcare solution for all members of your team no matter what their classification is. Sign up for a free demo with Thatch to learn more about your options.