As a business owner, there are a lot of things to consider when building a team. For example, you want to make sure you’re assembling a team of people that are dependable, adaptable, and have the skills and talents you need to take your business to the next level.
Another thing you need to consider when hiring your team? What type of team members it makes the most sense to hire—and, more specifically, whether you should be hiring full-time employees or independent contractors.
From the employee perspective, there are pros and cons to both employment structures. But what about for small business owners? Is it more advantageous to hire employees (either full- or part-time)—or does it make more sense for your business to build a team of independent contractors?
What Is The Difference Between W-2 Employees And Independent Contractors?
Before we jump into the pros and cons of hiring self-employed people vs. W-2 workers, let’s quickly touch on the differences between the two—and why understanding those differences is so important.
Whenever you hire a new person to work for your business, you need to classify that new hire (both for tax purposes and for your payroll platform), either as an employee or as an independent contractor. Depending on the worker’s classification, a specific form is used to report their taxable income to the IRS—a W-2 form for employees and Form 1099-NEC for contractors.
How you classify a worker will depend on their employment structure, job duties, and relationship to your business.
Generally, W-2 employees have work requirements that are set by the employer, including work hours and location. W-2 employees play a crucial role in the day-to-day operations of the business and also have access to a variety of employee benefits and perks (for example, things like healthcare/health insurance, workers’ compensation, employment training, or retirement plans, like a 401K or SEP IRA). Employers are also responsible for providing W-2 employees with any tools or equipment they’ll need to successfully perform their job duties—as well as covering any business expenses the employee incurs as part of their job.
So, for example, let’s say you hire a full-time graphic designer to help design all the assets you need to build and manage your business. Your full-time designer would be responsible for working the schedule you set for them (for example, 9am to 6pm every day) in the location outlined in your employment contract (whether that’s in your corporate office or at a home office). You’d also be responsible for providing them with any tools they need to do their job, like a work laptop and any relevant design software (or for reimbursing them if they purchase those things on their own).
On the other hand, contractors have a different type of relationship with their employers—a relationship with a lot more freedom. Unlike employees (who generally work for just one company), independent contractors are often freelancers or self-employed individuals who work with multiple clients and companies. As an employer, you can’t tell a freelancer when, where, or how to do their work—but you also aren’t responsible for providing them with the same level of equipment, tools, or reimbursements that you’d give to an employee.
So, for example, let’s say instead of hiring a full-time graphic designer for your business, you hire a freelance graphic designer to tackle a month-long project. As a contractor, that graphic designer can complete the project work when and where they choose (whether that’s at 9am or 9pm, at home or at a coffee shop). But, unlike when you hire a W-2 employee, you don’t need to equip the freelance designer with a computer or design software; as an independent contractor, it’s their responsibility to cover their business-related expenses.
So, some of the main differences between a W-2 employee and a contractor is the structure of the employment relationship and how the worker is classified for tax purposes—and, as a business owner, it’s extremely important to understand those differences, as misclassification of a worker’s employment status can lead to serious issues with the IRS (including fines and penalties).
Tax Liabilities For Employees And Freelancers
The other big difference between W-2 employees and independent contractors? How they’re paid—and the taxes that the business owner is required to withhold and pay on their behalf.
Employers are responsible for paying a variety of payroll taxes for their employees, including the employer portion of the employee’s FICA taxes (which covers both Medicare taxes and Social Security tax) as well as unemployment insurance at both the state and federal level (SUTA and FUTA). Employers must also withhold any relevant taxes from the employee’s wages, including income tax and the employee portion of FICA.
Taxes for contractors work differently. Because they’re not an employee of your company, you’re not required to pay any portion of their payroll taxes or withhold any taxes from their wages; the contractor manages their own taxes and is responsible for paying both the employer and employee portions of their Social Security and Medicare taxes (known as self-employment taxes).
What Are The Pros And Cons Of Hiring A W-2 Employee Versus 1099 Contractor?
So, now that you understand the differences between a W-2 employee and an independent contractor (including tax differences), let’s look at the pros and cons of hiring both types of workers.
- More Control. As an employer, you have more control in your relationships with W-2 employees, including setting their work hours, schedule, and day-to-day tasks.
- Higher Level Of Job Commitment. Because employees are working for your company long-term, they’re likely to be more dedicated and committed to their work and role.
- IP Ownership. Depending on your employment contract, employers typically own the rights to any intellectual property an employee creates at or for your business.
- More Of A Financial Investment... As an employer, you have to cover significantly more costs for an employee vs. a freelancer, including employee benefits, payroll taxes, and overtime pay (when applicable).
- ...And More Of A Time Investment. In addition to investing more money into your employees, you also need to invest more time in onboarding, training, and driving employee engagement.
- Less Expensive. Because you don’t have to pay payroll taxes to the IRS, benefits, or other expenses for contractors, they are less expensive to hire than an employee at the same pay rate (so, for example, a contractor that charges $50 an hour will generally be less expensive to your business than an employee with a $50 hourly rate).
- High Level Of Expertise. Most contractors build their business around a specific skill—a skill in which they have a high level of expertise. And when you hire them for a project, you get to leverage that expertise for your business.
- Fewer Logistics. Other than reporting your contractor’s wages using the right tax forms, all the other tax logistics fall on the contractor’s shoulders—so, as an employer, you don’t need to worry about withholding, paying for things like unemployment insurance, or any other logistical details.
- Lower Level Of Commitment. Because contractors aren’t employed by your business, they’re not going to be as committed to your company as a full-time, long-term employee.
- Less Control. Freelancers can work whenever, wherever, and however they want—and, as an employer, you don’t really have any say in the matter.
So, Which Is Better For Your Business — W-2 Or 1099?
So, bottom line—is it better to hire a W-2 employee or a 1099 contractor for your business?
It depends. There’s no right or wrong way to build a team; as a business owner, you need to weigh the pros and cons and hire the people who are going to be the best fit for your business—whether that’s employees, freelancers, or some combination of the two.