W2 Employee vs. Contractor: What’s The Difference?

Let’s first understand the difference between a W2 employee and a contractor.

A worker who performs services can be classified as one of three ways:

• W2 Employee: A W-2 employment relationship involves more than just the compensation part. Your employee is part of your team, and they must receive and follow your work guidelines, and abide by your work policy.You also have a higher responsibility towards your W-2 employees. You must pay workers compensation, and likely you’ll have to offer benefits, bonuses, health insurance and other fringe benefits.

• 1099 Contractor: 1099 contractors are more flexible. They’re not your employee, so you’re not responsible for paying payroll taxes or offering employee benefits. They serve more than one customer (you), and they are responsible for filing and paying their own employment taxes.Unlike an employee, you do not have any rights over work hours or work policies when it comes to hiring contractors. As long as they meet the requirements depicted in your contract, they are free to work when and how they want to.
• K-1 Employee: A K-1 employee is what’s known as a “key employee”. They have a direct and significant impact on the business, whether through strategic insights or skills and expertise that will help scale and grow your business. For K-1 employees, you have to offer more than just compensation and benefits.Key employees can become your potential successor, and you will need to offer equity to attract them. A combination of salary and profit sharing can be the solution.

How CA AB5 can change your hiring decision?

If you’re a California-based business, AB5 will add another level of complexity to your next hiring decision.

To classify a worker as 1099, they have to pass a test with three criteria, known as ABC test:

• Is your worker free of your control?
• Is the service performed outside the usual course of your business?
• Is the worker engaged in an established business for him or herself?

If you answer “yes” to all of the above. You can classify your worker as an independent contractor.

The Tax Benefits of W2 Employee vs. Contractor

Hiring someone on 1099 (contractor) can save you a lot of money in payroll taxes and workers benefits. In fact, you do not pay any payroll taxes at all for a 1099 contractor.

Additionally, the relationship can be terminated anytime, without an obligation on your part to pay a severance package or unemployment benefits.

On the other hand, hiring a W2 employee gives you more control over the worker’s schedule, services performed, and working conditions overall. But of course, this comes at a price.

For W2 employees, you must pay and file their employment taxes. You also need to train your employees, allow them to use your equipment, pay insurance coverage, and a pay a variety of other miscellaneous expenses.

It is significantly more costly to hire a W2 employee than a 1099 contractor. However, the benefits of a W2 employee may outweigh the costs.

Which One Should You Hire? W2 Employee vs. Contractor

Unfortunately, without knowing your specific circumstances and financial books, we cannot advise you on which type of worker you should hire through this blog post.

If you’d like specific advice for your business, you can schedule a quick 15-minute chat with one of our accountants here.

However, here are a few important questions you can ask yourself before hiring:

1. How many hours do you need to hire for? If you do not need 35-40 hours a week, it may be worth going the 1099 contractor route.
2. What is your budget? Cost will play one of the largest factors in determining W2 employee vs. Contractor. It is significantly less money and commitment to hire a 1099 contractor.
3. Are you looking for temporary help or do you want to build a team and grow? If you are only looking for short-term help, a 1099 contract role is the best way to go. However, if you are hoping to build a robust team to support the growth of your business, it will be important to bring in W2 employees that will stay and grow with your business long-term.
4. How much control do you need over the worker? If you are hiring for a role that does not require set hours or in-person commitments, a 1099 contractor may be your best route. However, if you require ongoing commitment from the person you are hiring, then a W2 employee is the way to go. 

Do you need more help in determining what kind of worker you can afford within your budget? Our accountants can help.

Schedule a quick 15-minute chat with one of our accountants here and we’ll be happy to help in any way we can.

Until next time!