Do you know how 1099 works? Do you know the difference between a W2 employee and a 1099 contractor? As employers, it’s crucial to understand how to classify workers – otherwise you can face hefty fines and other risks that have a huge impact on your bottom line.
It’s not only the employer of record that’s affected by misclassification. If employees are misclassified, they face several challenges including paying out of pocket during tax season. Though the responsibility falls on the employer, both parties must be knowledgeable about W2 vs 1099 and which classification is appropriate for the individual employee.
Below, we’ll define the differences between W2 and 1099 workers and the possible risks businesses may face with incorrect classification.
The Difference Between 1099 and W2
The best way to understand the difference between 1099 and W2 employees is knowing who the employer is in either situation. If an employee is classified as W2, you’re the employer. Under 1099 they’re an independent contractor (IC) and are technically self-employed; the worker is their own employer. In more layman’s terms, employers have more control over various employment-related factors under the W2 umbrella.
Besides its definition, the biggest difference between 1099 and W2 classifications is filing taxes and workers compensation insurance. We’ll go into more detail below, but first it’s important to understand that there are some situations that call for an independent contractor vs an internal employee. Here are three categories that “provide evidence of the degree of control” in your employee/employer relationship that will help you define whether the employee is W2 or 1099 (via the IRS):
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Unfortunately, there’s not one defined answer to decide if someone is an independent contractor or an employee. Typically you’ll seek out a 1099 IC when you have a specific assignment that can’t be accomplished by an in-house employee. Once the work has been performed, the assignment is over and the contractor moves on to their next client. Contractors have a fair amount of freedom and can set their own pay rates, working hours, etc.
But why would someone (accidentally or intentionally) misclassify a worker? Sometimes it may seem easier or more beneficial to utilize contractors for a W2 position. Hiring managers might be in a bind and need extra employees to account for seasonality or a last-minute request. Or they may think, “I don’t have to pay employment taxes or insurance.”
If you’re looking for someone to work on a consistent basis where you have more control over employment-related factors like pay and schedule, a W2 employee is right for you.
Classifications By Your Staffing Partner
If you’re partnering with a staffing agency, you must be aware of whether they’re classifying their employees correctly or not. In a traditional staffing agency/client relationship, the agency will hire temporary workers under the W2 classification. That means that the staffing partner is the employer of record and handles all the costs and paperwork associated with managing a W2 employee, such as:
- Workers compensation insurance
- Unemployment insurance
- Employee benefits
- Manages payroll taxes
The coverage of these tasks is the main reason companies opt to partner with a staffing firm to fulfill their hiring needs. If workers are classified as a 1099 contractor, the above is their responsibility to either cover or manage.
What happens if your staffing partner misclassifies their W2 workforce as 1099? The fact of the matter is, you can be held (at least partially) responsible if an incident were to occur. For example, if a 1099 IC gets injured, your property could be on the hook for the claim due to many states having “up the ladder” responsibility worked into their laws. ‘Up the ladder’ refers to a policy that ultimately means the worker (through their attorney) can find a party responsible for paying for the injury if the workers’ employer does not have workers comp insurance.
Not only that, but the property may face potential risk management issues such as benefit claims and other employment related matters if a misclassification were to occur. It’s crucial that whoever manages your staffing partner relationship knows whether workers are classified correctly. Sometimes the person making the staffing decisions just wants available workers for an event and doesn’t consider their classification. They see the event’s result and think everything is perfect, not realizing the potential risks being faced.
Now that we know how 1099 works, we understand the difference between W2 and 1099 classifications, and how that can impact employers, let’s look at our key takeaways.
- If you’re partnering with a gig staffing company, there’s a 99% chance their workforce needs to be classified as W2 employees. The most common industries and positions serviced by staffing companies have no reason to be 1099’d.
- Misclassification – whether by you or by the staffing partner – can lead to you being fully or partially responsible if an incident were to occur. This can cost you up to the tune of a million dollars depending on the situation.
- You need to do your due diligence to ensure that workers are classified properly whether they’re staffed internally or through an agency.
When you choose LGC as a staffing partner, you won’t have to worry about misclassification because we do things correctly – that’s why we’re celebrating our 20th anniversary this year. You can rest assured that our workforce is properly classified, removing the potential risks from your daily operations.