What is the Difference Between W-2 Employees and 1099?

The common question that many business owners ask is whether they should hire employees or independent contractors. Knowing the difference between a W-2 employee and 1099 contractor is important in order to maintain compliant with federal and state labor laws. Employers have a responsibility under federal employment laws to properly classify each worker as either an employee or independent contractor before any work is performed.

W-2 employees are individuals who are hired to work for an employer on a full-time basis with set hours, duties and responsibilities. W-2 employees are subject to employment taxes under the Federal Insurance Contributions Act (FICA) and must be paid at least minimum wage ($7.25 per hour effective July 24, 2009) and other benefits as required by state law. An employer withholds federal, state and other taxes from the W-2 employees' wages before they are paid, and pays a matching share of FICA taxes for each employee.

In contrast to a W-2 employee, an independent contractor is hired to work for a business and is responsible for their own tax withholdings. Independent contractors are often paid on a per-job basis without benefits or payroll withholding taxes. If you have an independent contractor who has performed services for your business, it is important that he or she also not claim to be your employee when filing their income taxes.

While the difference between W-2 employees and 1099 contractors may seem clear cut, it is not always easy to distinguish the status of a worker. Businesses must be able to show that an individual who provides services to them is their employee and not simply doing their own thing (i.e., contracting out part-time work).

A common mistake for employers occurs when they do not pay independent contractors enough or show that the employees are still under their control while they perform services for other employers. While it may be tempting to save money by hiring independent contractors, you could end up facing steep fines if you are found out by the IRS. Sometimes, it may even cost you your business.