As companies begin to regroup and recover from the pandemic, many will hopefully begin to rehire. If you’re in that position—that’s great news. As you begin the hiring process, however, you’ll want to consider whether employees or independent contractors make more sense and ensure you classify your hires correctly.
The latter is exceptionally important in the eyes of the IRS, and could lead to big penalties if done incorrectly. The workers you hire fall into one of two categories: a W-2 employee or a 1099 independent contractor. There are pros and cons to each type of hire, and it’s worth doing a cost analysis to determine which type makes the most sense for your company and the work you need to be done.
Make smart use of each type of hire—especially now as you’re navigating a challenging economy in post-COVID-19 era—and you’ll accelerate your company’s growth, and save money in the process.
The true cost of a new employee
Many companies laid off or furloughed people in the midst of the coronavirus pandemic. Now as things return to a new normal, business owners may need to grow their workforce once again as the economy and small businesses begin to recover. However, before you can decide whether your next hire should be a 1099 contractor or W-2 employee, it’s important to understand the costs of re-hiring in the first place.
In addition to what you plan to pay the person as an hourly wage, you’ll also want to figure in the time it takes to recruit, onboard, and train a new employee. To calculate how much a hire truly costs consider the expense of:
- Placing job ads
- Time reviewing applications and interviewing candidates
- Time and resources spent on onboarding materials
- Role-specific training
- Overhead required to maintain employees such as desks, tools, etc.
- The hourly wage of the job
- Benefits or other perks offered
The costs will vary by industry and the overall expertise and wage-level of the role you’re trying to hire. In general, research shows that employers should multiply the cost of an employees’ wages by 1.2 to 1.4 times to account for the total hiring expense.
Independent contractor versus W-2 employees
Once you decide to expand your staff, you want to understand the advantages of the two classifications of hires you can make. Both can help businesses meet their labor needs, but knowing the difference between the two is imperative—a misclassification of employees can lead to penalties from your state and federal departments of labor.
A 1099 employee is not an employee of your business, but an independent contractor. That means that the person technically is self-employed, and you pay for a service the person provides. That service may be a set amount of hourly work or the completion of a defined project. The person usually works on a contract. They receive a form 1099-misc from your company to report on their tax return, and they pay their own social security, income tax and medicare tax. 1099 contractors typically set their own schedules, or at the least, agree to a schedule in conjunction with their employer or client.
Meanwhile, a form W-2 employee is regularly paid employee, who often receives healthcare and other benefits. The employer controls most aspects of the employee’s work, and though it’s not mandatory, they’re often full-time workers. They are hired as employees for an indefinite amount of time.
W-2 employee classification is the default for most employees hired. Their employment is regulated and protected by federal employment law, and W-2 employees are guaranteed to earn at least minimum wage. In addition, employers pay employment taxes—at least a portion of them—on behalf of their employees. Employers are mandated to withhold income tax via employees’ paychecks for federal income taxes.
How to classify your hires
The IRS notes that there’s no one factor that determines whether a hire is a contractor or W-2 employee, but instead, there are several to consider. The overarching nature of the relationship and the control the employer has over the hire’s work are probably the best determinants. Consider the following:
- Will your company be in control of what the person does and how and where the work is performed?
- Will your company be in control of how much the worker is paid, as well as determine other financial aspects of the work, such as reimbursement for expenses?
- Does the employee receive benefits such as healthcare and sick leave?
- Does the employee work full-time?
If the answer to these questions is yes, then the hire should likely be a W-2 employee. Classifying a W-2 employee as an independent contractor can be exceptionally problematic; you can end up owing back taxes and wages to the IRS, as well as incur fines from the department of labor or even face lawsuits.
Does a W-2 employee or 1099 independent contractor make sense?
Each type of hire serves a purpose. For example, if you need to ramp up quickly to meet demand as the economy picks up steam after COVID, then 1099 contractors can be a good option. Contractors can fill in key gaps. You can get a feel for your new revenue picture and budget, without the obligation of a longer-term hire. Businesses also often rely on contractors to provide a level of expertise or special service that they may not need all the time.
1099 contractors are easier to hire—you simply draft up an agreement and get working. There are very few legal ramifications; you can let them go at any time. And importantly, 1099 contractors may be less expensive than hiring a permanent full-time person. You save on recruitment, training, onboarding, healthcare benefits, and more.
Meanwhile, W-2 employees likely form the base of your workforce. You invest time in training them, and they become a key component of your company. They offer stability for the business, and continuity for your customers.
Managing new employee costs for contractors and W-2s
Regardless of how you classify your employees, finding ways to manage costs is especially critical during uncertain times. You want to ensure you’re running your company in an as efficient manner as possible, making the most of your W-2 employees and implementing contractors to give you expertise and extra manpower when you need it most.
Utilizing a time tracking application such as Hourly provides you the insights and data required to make smart decisions about the types of hires you need. Such a solution can also help you better manage the costs of new hires. For instance, with Hourly you can:
- Easily review a payroll summary of hours worked by your workforce. You can assess whether certain roles require full-time attention, how a 1099 contractor may come into play, and whether you’re under or overstaffed for the amount of business you currently have.
- Set limits on how many hours people work. You can create custom rules that denote how many hours each employee or hire can log. This can be especially helpful if you are managing 1099 employees—you can get alerts if they’ve entered more hours than set in your contract and ensure they’re meeting the parameters of the contract and not exceeding what was agreed upon.
- Seamlessly onboard new hires. Getting employees set up on a time tracking system should not require extensive training. With Hourly, employees simply receive an invite via text. They download the time tracking app and can begin using it—no extra work required from your HR or onboarding team.
Let’s Wrap It Up
The hiring of employees is one of the first tasks you’ll do as we emerge from the COVID-19 crisis. Understand the difference between a 1099 contractor and W-2 employee and when it makes sense to use each. You’ll avoid problems from misclassification, save money by utilizing the right types of employees in the right roles, and ultimately prepare your company for growth and success.