The more your business grows, and the more you progress toward the future of work, the more you’ll find yourself flexible in leveraging both independent contractors and full-time employees. 

But with this flexibility comes the responsibility to carefully manage the compliance aspects behind a dynamic, mixed workforce.

If you’ve landed here, it’s likely that you’re struggling with tax issues or facing compliance considerations as you scale the teams.

For those not familiar with the legal terms, 1099 and W-2 are classifications used to determine the types of employees based on the tax forms required in the U.S. 

Simply put, a 1099 contractor is an independent worker who handles their own taxes, and a W-2 employee is someone whose taxes and benefits are managed by the company.

Understanding the difference between 1099 contractors vs W-2 employees is important to making hiring decisions and staying compliant afterward.

That’s exactly what I’ll cover in this article: what you need to know about 1099 vs. W-2, along with the implications for recruitment compliance when expanding globally.

What are 1099 Contractors?

Given the benefits of remote work and the embrace of the skill-based recruitment approach these days, no wonder why the gig economy continues to thrive.

ADP data shows that in 40% of companies, one in four workers is a gig worker. The latest data from Statista as of July 2023 reveals 72.1 million Americans (21.5%) engage in gig work, 26 million of which contract work for more than 15 hours a week.

A 1099 contractor, often referred to as an independent contractor, is an individual hired to perform specific tasks or services for a business but is not considered an employee. 

Unlike W-2 employees, who are under the direct control and supervision of an employer, 1099 contractors work independently, often setting their own hours and using their own tools or methods to complete the assigned work.

The term "1099" refers to the IRS tax form that you need to file for your contractors, specifically the 1099-NEC (Non-Employee Compensation). 

1099-NEC reports the income earned by the contractor over the year. 

Businesses must issue a 1099-NEC to any contractor paid $600 or more during the tax year. 

The contractor is then responsible for reporting this income and paying self-employment taxes, which include both the employer and employee portions of Social Security and Medicare taxes.

For example, if you hire a freelance graphic designer for a rebranding package for $2,000, at the end of the year, you need to file a 1099-NEC for that transition.

There are various types of 1099 contractors, including:

• freelance writers
• graphic designers
• consultants
• advisors
• IT specialists

Essentially, any professional who provides services to multiple clients or businesses, rather than being tied to one employer, can be classified as a 1099 contractor.

What are W-2 Employees?

W-2 employees are those who work directly for your company, whether they are full-time, part-time, or interns. They could be your office team, sales team, or customer service reps—anyone who follows the schedules and guidelines you set. 

Unlike contractors, these employees are under your direct control and benefit from things like regular paychecks, health insurance, and paid time off.

The W-2 form, which you’re responsible for issuing, is what reports each employee’s earnings and the taxes your company has withheld. This form is vital for employees when they file their taxes, so accuracy is key.

And it might be overwhelming for your team if you’re scaling up quickly and that’s when you might hire just a 1099 contractor for support.

Related: 2024's Best Free Payroll Software & Trials for Startups & Small Teams

You need to ensure that all tax-related aspects for W-2 employees are handled correctly. This includes withholding federal and state income taxes, as well as Social Security and Medicare contributions from their paychecks. 

If you make a mistake here, it’s time-consuming to fix and could potentially lead to other serious issues, which can be stressful to manage, especially as your business grows.

Differences Between 1099 and W-2

When making decisions under the perspective of 1099 vs W-2, it’s likely that compliance is at the forefront of your mind. 

Here are some rounded differences that can help you weigh your decision between 1099 contractors and W-2 employees:

1. Control Over Work

One of the most significant differences is how much control you have over how the work gets done. With a W-2 employee, you have the ability to dictate the when, where, and how of their daily tasks. They follow your schedule, use your tools, and adhere to your company’s processes.

On the other hand, 1099 contractors are more autonomous. They typically work on their own schedules, use their own equipment, and decide how to complete the tasks you assign them. 

If you need someone who will be closely managed and deeply integrated into your team’s daily workflow, a W-2 employee might be the better fit. 

But if the task allows for more independence and you’re comfortable with less oversight, a 1099 contractor could work well.

2. Costs and Benefits

Another key difference is the financial impact on your department’s budget. 

W-2 employees come with a range of additional costs beyond their salary. 

You’re responsible for payroll taxes, benefits like health insurance and retirement contributions, and possibly other perks like paid time off. These add up, but they also contribute to employee retention and satisfaction.

1099 contractors don’t come with these extra costs. You pay them the agreed-upon rate, and they’re responsible for their own taxes and benefits. 

This can make them seem like a more cost-effective option, especially for short-term or specialized projects.

3. Flexibility vs. Commitment

Think about the flexibility you need versus the commitment you’re willing to offer.

W-2 employees are typically long-term hires. They provide stability and consistency, which is great if you need someone who can grow with the company, learn the ins and outs of your processes, and be a reliable part of your team.

1099 contractors offer more flexibility. You can bring them in for specific projects or during peak times when you need extra hands, without the long-term commitment. 

However, because they’re not exclusive to your company, they might not be as available or as invested in your company’s success as a full-time employee would be.

4. Legal Implications

Misclassifying a worker can lead to serious legal and financial consequences, so it’s vital to get this right. 

W-2 employees are protected by a host of labor laws, including minimum wage, overtime, and anti-discrimination protections. You need to provide them with benefits like 401(k) and other compensation.

1099 contractors, however, aren’t entitled to these protections or benefits. 

But if the IRS or state authorities determine that you’ve misclassified an employee as a contractor, your company could face hefty penalties, back taxes, and even lawsuits.

Which One Should You Hire: 1099 vs W-2?

At the end of the day, we just want to bring the best talents in to form a stronger team dynamic and drive the business to new heights. While the compliance aspect is crucial, it shouldn’t be among the decision factors of hiring.

Here are some specific situations when it makes sense to:

Leverage 1099 Independent Contractors: 

• For projects that require specialized skills or are time-limited, independent contractors are your go-to option. They bring in the expertise you need without the long-term commitment, allowing you to complete the project efficiently and effectively.
• If your business experiences fluctuating workloads, contractors provide the flexibility to scale up or down as needed. This is particularly helpful for teams dealing with peak seasons.
• For short-term needs, contractors can be more cost-effective. You avoid the added expenses of benefits, payroll taxes, and other costs associated with full-time employees. Essentially, you’re paying for the work done, nothing more.
• When your project demands niche skills that your current team lacks, hiring an independent contractor with that expertise can be the perfect solution. They bring in the necessary know-how to get the job done right.
• Exploring new markets or trying out a role that doesn’t yet justify a full-time position? Contractors allow you to test the waters without committing to a permanent hire, giving you valuable insights with minimal risk.

Related: The 9 Best Contractor Management Software for Streamlined Management

Invest in Permanent Hires:

• If the work is ongoing and critical to your business, a permanent employee ensures consistency and reliability, providing a stable foundation for your operations.
• Permanent employees are more likely to be deeply invested in your company’s culture and long-term goals. They play a key role in building a cohesive team and contributing to a strong, unified workplace environment.
• With W-2 employees, you have greater control over work processes and can align their efforts more closely with your company’s objectives. Their commitment to the company’s success is often stronger, leading to better overall outcomes.
• Roles involving sensitive or confidential information are best suited for permanent employees who are fully integrated into your company’s operations and policies. This integration ensures greater security and trust.

Why Does 1099 vs W-2 Matter?

The moment you submit a W-2 or 1099 form to the government, you’re declaring the employee’s status to the authorities. This action carries significant weight, as it categorizes the worker under specific labor laws and tax obligations, which will define their rights and your responsibilities as an employer.

The IRS uses the 20-Factor common law test to determine whether a worker is an employee or an independent contractor. This test evaluates key factors such as the level of control you have over the worker’s tasks, the financial relationship, and the nature of the work being performed.

Beyond the IRS, many states have their own criteria for classification, such as California’s Dynamex ABC Test which is stricter. 

Your submitted W-2 and 1099 forms will determine how taxes are withheld, the worker’s eligibility for benefits, and whether you’re in compliance with labor laws. 

If you incorrectly classify an employee as a contractor and file a 1099, you risk facing audits, investigations, and the possibility of owing back taxes and penalties. 

This is why it’s crucial to ensure that your classification reflects the true nature of the working relationship right from the start. Filing the correct form is not just a bureaucratic step—it’s a reflection of compliance with legal standards that protect both your business and your workers.

Tools like Deel can make your life easier by handling the employee classification for you as well as managing payroll, HR, compliance of the entire workforce in a single platform. This helps you lighten the load on the legal side to focus on other HR functions and managing remote teams.

Other Legal Considerations for Global Dynamic Workforce

At its core, you’re weighing the decision between independent contractors and employees. And it doesn’t have to be limited by geographical boundaries.

Hiring international talents means tapping into a larger, more diverse, and richer talent pool, giving access to a wider range of skills and expertise. 

If you wish to do so, there are some considerations for a global “1099 vs. W-2” decision. 

Navigating Different Laws and Regulations

Employment laws and regulations vary from country to country, and you cannot just assume that your usual practice works.

What qualifies as an independent contractor in one country might not meet the same criteria in another. 

Streamlining Payroll for Global Teams

Managing payroll across various countries adds another layer of complexity. 

It’s essential to ensure that your payroll processes comply with the tax laws and social security requirements of both your home country and the country where your contractor or employee is based. 

For independent contractors, this might mean navigating cross-border tax regulations, while for full-time employees, it involves setting up comprehensive payroll systems that handle everything from tax withholdings to benefits, all while staying compliant with local laws. 

Your goal is to ensure seamless and compliant payroll operations across your global workforce.

Protecting Intellectual Property (IP)

Intellectual property protection becomes even more critical when working with global talent, especially independent contractors. 

Different countries have varying rules on IP ownership, and without clear contracts and agreements, you could face disputes over who owns the work produced. 

For more, explore our detailed guide on Remote Hiring Legal Considerations.

Wrapping it Up

It’s clear that 1099 contractors vs W-2 employees, each has their own distinct advantages and considerations. 

I hope this guide provides helpful information for your recruitment compliance questions. And please remember, you don’t have to navigate through it all alone!

Given the complexities of legal and compliance requirements, which aren’t everyone's expertise, it’s often best to consult a legal expert in the country where you’re hiring—or better yet, partner with a reliable employer of record.

For more, check out my curated list of best Employer of Record Services in 2024.