OCB: W2 Employee versus 1099 Independent Contractor


When a company retains an individual to perform a service for the company, it must determine whether the individual will be classified as a W2 employee or a 1099 independent contractor. The type of service being rendered will typically determine whether an individual is an employee or independent contractor, but where there is a gray area, companies will typically prefer independent contractors while individuals will typically prefer to be employees.

1099 Independent Contractor
If a company is hiring an individual on a one-time basis, or if he is purchasing services from an individual organized as a sole proprietorship, the company will typically issue a 1099. This document is required in the case that over $600 of payments is made to the individual during a calendar year, and filing this document allows the company to claim the payment as an expense. The 1099 is issued by January 31 of each calendar year to all 1099 status contractors from the previous year. The company should typically issue a W9 (request for taxpayer information) while the independent contractor is being engaged, and this will indicate to the individual that he will be receiving a 1099 at the start of the next calendar year.
The benefits for the company hiring on a 1099 status is that there is no obligation to retain an individual for longer than the period that it takes to perform the work, there is typically no sort of health or benefit obligations, there are no additional payroll payments that need to be handled, and the company retains the flexibility from having a lower employee base. The benefits for an individual working as an independent contractor is that they do not typically have any of their payment withheld up front (though they need to make quarterly tax payments via 1040-es) and they can take deductions for business expenses.
Note that when purchasing services from certain companies, a 1099 must also be filed, but this filing will not be covered in this article.
W2 Employees
If a company is hiring an individual on a long-term basis, and if the individual is working on-site at the company's premises, the individual will typically be a W2 employee. The W2 is a document issued by January 31 of each calendar year that includes a summary of payments made by the company to and on the behalf of the employee. This includes wages, federal income tax, state income tax, and FICA. Ongoing payroll payments are difficult to calculate in-house, and payroll is typically managed by a third-party vendor.
A company does not receive many explicit benefits from hiring W2 employees, although typically as a company grows they have no choice but to have full-time workers as W2 employees. For individuals, there are typically numerous benefits to being a W2 employee. They receive protection from discrimination in both the hiring and firing process. They will typically receive health care and benefits such as paid time off or sick leave. The employee will pay a portion of the social security tax. For most individuals, having a regular day job will fall into the category of a W2 employee.
Conclusion
While a company will have some preference for hiring 1099 contractors rather than W2 employees, a company must be careful when dealing with borderline cases. Wrongfully classified employees have the right to sue an employer for the value of withheld benefits and the company may also be liable for employment taxes that have not been paid.
To determine whether an employee should be classified as a 1099 contractor or W2 employee, please refer to this 11-point test from the IRS: http://www.twc.state.tx.us/news/efte/appx_d_irs_ic_test.html

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