Employee (W2) vs Contractor (1099)

9/15/2023 - By Abigail Pombert

Point of View: You own a small business. Business is starting to pick up, and you are getting overwhelmed with the day-to-day operations as a one-man show. You are debating hiring an employee or two to help out, but you are struggling to decide whether you classify your new worker as an independent contractor or a common-law employee. Let’s walk through some questions to ask yourself to choose what type of worker is right for your business. 

Contractor Versus Common-Law Employee

A contractor operates independently of your business on a contract basis. For example, you hire a contractor to paint your office building. Once the building is painted, the contract has been satisfied, and they are no longer obligated to perform any other service for you. You do not have control over when or where they work. For example, they will paint your building when they are available, not necessarily when you are available. They can have as many contracts as they want with as many people as they want. A common-law employee is someone who works for you in a more controlled manner. For example, you hire a receptionist for your company. He/she is required to work on the schedule that you provide, e.g., a weekly schedule of Monday-Friday 8 a.m.-5 p.m. You pay them an hourly wage with benefits. He/she is your employee.

Common Law Rules

There are three common law rules that determine the degree of control and independence for an employee - behavioral, financial and type of relationship:

Behavioral

  1. Do you control or have the right to control what the worker does day in and day out?
  2. Do you control or have the right to control when the worker shows up to work
  3. Do you control or have the right to control how they do their job?
  4. Do you provide training on how to perform the tasks assigned to them?

If your answer to any of these questions is “yes”, they will most likely be classified as an employee versus a contractor.

Financial

  1. Will your company reimburse the worker for business-related expenses, such as mileage, other travel costs, software programs, etc.? If yes, this could be an indication that they should be classified as an employee. A contracted worker isn’t typically reimbursed by the company. They have their own business and will take those expenses as deductions on their return.
  2. Does the worker have a significant investment in the tools that he/she uses? For example, you hire a digital marketer to perform ongoing design and advertisements of your website. They have their own computer and software programs to complete the job. They are considered to have a significant investment in their own tools. If they have significant investment in their own tools, they might be a contractor.
  3. Are they free to offer and perform their services to other businesses? If the answer is yes, then they may be a contractor.
  4. Do you pay them a regular wage on a periodic basis versus when the job is completed? If the answer is yes, they are most likely an employee.  

Type of Relationship

  1. Do you provide any sort of employee-type benefits (insurance, paid time off, a pension plan, paid maternity leave, etc.)?
  2. Is this a permanent relationship or will it only last for the duration of the project?
  3. Does this worker provide a key function to your business? 

If the answer is “yes” to any of the above questions, you most likely have an employee.

Classifying Your Worker

Once you have determined the right type of worker for your business, it is important to classify them correctly. If you have determined that you need a common-law employee, your company is liable for the payment of employment taxes on that employee.

If you hire a contractor and pay them $600 or more within the year, you must provide them with Form 1099-NEC. You do not need to pay employment taxes for a contractor. They are responsible for their own FICA and estimated tax payments.

To find the forms needed for either type of worker, go to IRS.gov.

Questions?

If you have any questions, please reach out to our Tax Consulting Group. We are happy to help in any way that we can!

 

About the Author | Abigail Pombert

Abigail is a senior in the Tax & Accounting Services practice of Saltmarsh, Cleaveland & Gund. She provides a variety of tax and accounting functions, such as the preparation of individual, corporate and trust and estate tax returns and financial statements. Previously, Abigail was an intern with the firm and conducted research on tax law and regulations and analyzed their application to individual client circumstances. Learn more about Abigail

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