What do you think is the role for the Human Resources (HR) managers? Do you know that HR is one of the biggest challenges when operating a business? Human resources personnel have a very critical role in keeping the business in compliance with regulations while also managing payroll, employee relations, onboarding, and a myriad of other HR duties.
Organizations that lack a devoted HR team make it hard to handle payroll administration, onboarding, employee relationships, as well as other related HR tasks. Additionally, there is the time cost of such responsibilities, which requires you to account for the financial costs of staffing which, based on your industry, can consume between 40 percent and 80 percent of your organization’s budget.
Do small businesses need to be keen when employing a 1099 or a W2 employees for specific responsibilities? Yes, employing independent contractors or 1099 workers can help you to cut back the legal responsibilities and costs.
However, there are major differences that exist between the two types of workforces, and categorizing them appropriately is important. Else, you could face penalties from the IRS or even a case against your business. Therefore, you should get employment assistance from an employment lawyer when categorizing employees.
So, what are 1099 Workers?
While working with independent contractors, you will report their benefits on a Form 1099-MISC as long as their pay is at least 600 dollars for services performed. You must understand that there are different terminologies to refer to 1099 workers, which include freelancers, self-employed individuals, or gig workers. Such employees are business owners who offer a set service to your organization and are not on your payroll and include an employee of a company.
How about W-2 Employees?
After hiring employees, whether, on a part-time or full-time basis, W-2 workers will require you to report their salaries and all benefits for the year through a Form W-2, which will show the withholdings made from the worker’s pay. Your workers will then use the form to report their earnings on their taxes.
Source: (Brewster & Soderstrom, 2017)
What control do you have over W2 Vs 1099 Workers?
As an employer, the main difference between 1099 workers and W-2 is the level of control you have. For W-2 employees, Brewster and Soderstrom (2017) pointed out that you can direct the work being done. This implies giving instruction, training, and tools to do the work. You also set their schedules and hours.
According to the IRS’s fact sheet on worker vs contractor designations, the law is that an employee is an independent contractor if you can control only the completed work, not how or when, or what is done. On the other hand, 1099 contractors use their selected methods and equipment to complete their work. Although they may work for a particular period or project, they use their plan.
They can also offer similar services to other companies and can turn down or accept work opportunities if they wish. Because the precise classification of employees is so vital, the IRS gives guidelines to assess the scope of control you have to help them determine if you are an employee or contractor:
Do W2 Vs 1099 Workers affect organizations Culture?
W-2 workers bring workers on board who fit within an organization and reflect on organizational values. Such workers become part of an organization’s team and work environment and contribute to an improved company’s culture, which can help to recruit and retain customers. Also, employees may feel more secure in their duties. Thereby contributing to an increased focus because they will not always be looking to line up the next employment.
On the other hand, 1099 contractors are not an investment in organizational culture. This is because they usually complete an assignment, then go on to the next one. This can be disruptive for other workers and cultures. However, the temporary nature of 1099 workers can be a benefit because there is no obligation to work with the contractor after their project is done, which makes it easier to end the relationship than terminate an employee.
How are duties allocated between W2 Vs 1099 Worker’s?
You can control what W-2 employees work on. This implies that you have control over how the work is done and when. Part of controlling their work also implies you can allocate various tasks to employees. Think of a job description and how many duties are listed. This flexibility helps you focus workers on projects or areas where they are required most.
1099 workers get a particular job completed and can apply their own will. This can free you from management challenges. Because you hire contractors for particular services that you have agreed, you do not have the luxury of tasking their other responsibilities without changing the extension of your agreement.
Also, they set their hours and deadlines to complete the work. This could lead to reliability, particularly if they have other customers, they are working for that may affect their delivery dates and schedules.
What about Payroll Taxes?
They are automatically subtracted from the paycheck of W-2 employees. Being an employer, you must suppress pay Medicare taxes, income taxes Social Security, as well as unemployment tax on paid wages. During taxation, you will need to provide workers with a W-2 that shows the amount of taxes withheld from their wages.
For 1099 workers, you will have to give a Form 1099-MISC to show what you paid if they got 600 dollars or more within the year (Goldslager, 2020). Those who work as contractors will use the 1099s to calculate their net earnings and their self-employment tax, which they will submit directly to the IRS.
Self-employment tax is 15.3 percent, which is double what a W-2 worker pays after employers pay half the taxes for the payroll. However, regarding taxes, the one upside for 1099 employees is that most of their incurred expenditures while completing their work can be subtracted.
What are the costs associated with W2 Vs 1099 Workers?
For W-2 employees, you may pay less per hour for the same work than for 1099 workers. However, there are other associated costs. You are responsible for the management of payroll and mandatory tax payments and contributions for your workers, inclusive of your share of Medicare and Social Security and state unemployment compensation insurance and workers’ comp.
You will also factor in the cost of all benefits you give your workers, office space, and equipment. There is a continuous challenge of employees’ management and motivation, which can take more time and resources.
For 1099 contractors, you do not incur a lot of expenses. Savings are valued between 20% and 30% when using 1099 workers (Goldslager, 2020). It can not only be less costly to hire a 1099 worker, but contractors can also save you expenses in other ways. For instance, you will not pay out unused vacation when they leave the job.
Because many 1099 workers are specialists, you may spend less on training even though when they leave, they will move out with their skills. Because contractors are not subjected to the same protections under the law, you may not incur legal expenses that arise from claims against you.
How do state specific items vary regarding employees and 1099?
Let us use California as an example. The two types of workers exist in California. For the purpose of taxation, classifying a worker will affect the IRS tax form that companies should prepare. For employees, employer will be required to give them a copy of IRS Form W-2. For Independent Contractors, there should be a complete copy of IRS Form 1099-MISC given by the employer. So, does classifying workers affect imperative legal rights?
Under the law of California, there are many legal examinations to look at whether a person is an independent contractor or employee. Such tests are similar in most states, but not alike. The suitable test depends on the rights or duties at issue. The most imperative are the “control” test that the IRS uses for federal tax purposes.
Also, there is the “ABC” test, used for most hour and wage purposes under the state law. Moreover, it is the “means and manner” test, used as a reserve under the state’s hour and wage laws where ABC test do not apply. Finally, there is the “economic realities” test used by federal courts. Even though every test is somewhat different, there is one main factor in each: the extend of control of the hiring party over the employers.
IRS form 1099 reporting for small business owners in 2020 (Adhikari, Alm & Harris, 2021).
What recommendations do you suggest for employers?
Whether you employ staff as employees or enter into contractor relations, there are a lot of things to consider. One or both can contribute to the organization and help people to meet their goals. A W-2 employee will be a good fit if you want dedicated workers productive and loyal over the long term or if you prefer keeping the knowledge and skills of the worker in-house. Also, they are important if you have a different corporate culture that you need to foster and uphold.
On the other hand, 1099 workers will be right for the business if you do not want to pay payroll taxes or benefits to reduce your costs. Also, they are important when you do not prefer investing time or resources in training but bringing in specialized knowledge. Finally, they are preferred when you want the flexibility to end a relationship when an assignment is complete or as allowed by your budget.
Should HR managers be liable for their choice of employees? Because the HR team is usually in charge of recruiting and hiring workers, it must have the knowledge and the characteristics that differentiate W-2 workers from independent contractors. Though there is no test for classifying for a worker, the United States (US) Small Business Administration recommends businesses consider the following strategies.
First, they should look at the nature of the relationship. Is it temporary or permanent? Second, what is the amount of the contractor’s investment in equipment and facilities? What is the nature and level of control by the employer? Further, are the services provided an important part of the owner’s operations? What is the contractor’s chance to generate profit or loss? Finally, what is the level of judgment, creativity, and prudence that is needed for the contractor’s success in a modern competitive market?
To avoid employee misclassification, HR personnel should have job descriptions that state the need for a worker or independent contractor. After hiring, HR should ensure the business has a W-9 on file for each independent contractor. The form needs to be collected at the start of the contract. Further, independent contractors must take care of invoicing for every service and HR should assure this statement is in the written contract.
If employers are unsure of the worker classification, the worker or the HR can file IRS form SS-8. The IRS will evaluate the details and examine if the individual is an independent contractor or employee. It is vital to note that returning the form and classification can take six months, therefore HR should file in advance as possible.
Not understanding the difference between an employee and an independent contractor can have expensive consequences for businesses. It is important to note that HR clearly understands the terms and provides the proper compensation and benefits based on the classification.
Summary
Both independent contractors and employees can be important assets to a business because they perform the work you need to operate the business. It is imperative to understand the differences between these two and evaluate your needs. If you require a strong sense of management over the work and the worker’s time, you are better off engaging an employee. You should avoid falling into the trap to call a worker a contractor because that can haunt you. Taxes can pile up quickly, particularly if you add penalties and fines.
References
Adhikari, B., Alm, J., & Harris, T. F. (2021). Small business tax compliance under third-party reporting. Journal of Public Economics, 203, 104514.
Brewster, C., & Soderstrom, M. (2017). Human resources and line management 1. In Policy and practice in European human resource management (pp. 51-67). Routledge.
Colella, F. G. (2019). Sec. 7434 Claim Can Proceed Where W-2 Employees are, Instead, Fraudulently Issued Forms 1099. Taxes-The Tax Magazine, 97(7).
Goldslager, L. (2020). 5 Reasons I Switched from a Salaried Employee to a 1099 Independent Contractor. Leader Live.