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ResourcesBusiness 101

1099 Contractors vs. Employees: What's the Difference?

The ultimate guide to hiring 1099 contractors
Business 101April 04, 2023

Working independently has never been so popular. According to Statista, over 60 million Americans did at least some work as independent contractors in 2022—a significant increase over previous years. 

Part of this is likely a result of the Great Resignation, where mass numbers of workers left their jobs following the start of the COVID pandemic. Another factor may be workers starting side hustles to bring in a little more money. Whatever the reason, it’s clear more people than ever are interested in working for themselves as 1099 contractors.

Hiring 1099 independent contractors can be an excellent opportunity for your business. It can also be a bit confusing if you’ve never done it before, and it can have significant implications for your self-employed taxes. In this article, we’ll explore the details of what makes a worker an independent contractor, how they’re different from W-2 employees, and how you can have a better experience working with contractors this year. 

How 1099 contractors are different from employees

Working with independent contractors can be quite different from traditional employees. If you’ve never hired a contractor before, here’s what you can expect to be different.

1099 contractors 

Independent contractors are self-employed individuals. They often own their own business, and your business enters into a contract with them to complete a project or do a certain job for a given length of time—hence the term independent contractor. They often work at their own pace, on their own schedule, and using their own tools. Independent contractors may also perform the same work for multiple businesses at once—potentially even competing businesses.

Beyond how they get their job done, 1099 contractors also have different rules and requirements around taxes, benefits, and insurance. Since they’re self-employed, you don’t generally need to withhold taxes for them—that’s their responsibility. You also usually don’t need to provide any benefits, like health insurance or vacation time. 

When it comes to taxes, independent contractors are 1099 workers. This means you’ll file a 1099-NEC form to report your payments to them. 

Employees

Employees are workers that are hired by your business on a full-time or part-time basis. There’s typically an employment agreement involved that specifies the duties they’ll perform and the compensation they’ll receive in return. 

In contrast to 1099 contractors, employees generally have to work at a pace and schedule you set, and you’ll typically provide the tools, equipment, and training they need to perform their job. You’re responsible for withholding employment tax for them, and you may be required to provide benefits for them. Employees are W-2 workers—this is the form you’ll file for tax purposes. 

Factors that determine whether a worker is classified as a 1099 contractor or an employee 

There’s not necessarily a clear line that determines whether an employee is a 1099’er or a W-2’er—at least not in the eyes of the IRS. Obviously, if you hire someone full-time, there may not be much question in your mind. However, for tax purposes, you may find that you have some workers that fall into a gray area. Let’s break down some of the distinctions, starting with the IRS guidelines

Before we dive into these guidelines and qualifications, it’s important to note that some of this may be changing in 2023. The Department of Labor (DOL) is considering a proposal that will change the way some workers are classified. 

If it’s approved, many current contractors that are “economically dependent” on a company will be reclassified as employees of that company. The goal is mostly to ensure that workers aren’t taken advantage of, but like any ruling of this sort, may have a number of residual effects.

IRS guidelines for 1099 workers 

The IRS looks at three main areas to decide whether a worker is a 1099 contractor or W-2 employee: behavioral, financial, and relational.

  • Behavioral: This is the degree of control the company has over when and how the worker does their job. In other words, how much freedom do they have to work the way they want?

  • Financial: Financial considerations include how the worker is paid, whether your business covers expenses, and whether they provide their own tools and equipment.

  • Relational: You should consider the types of contracts or employment agreements in place with the worker, as well as whether they’ll continue to work for you once the current project is over. 

The main thing to keep in mind is that there’s not a single equation that definitively says one worker is a contractor and another is an employee. Each situation is unique. 

If you’re really stuck, the IRS provides a worksheet you can use to help make a determination—Form SS-8. You can file this form and the IRS will review the situation and circumstances and make an official determination of the worker’s status. However, do note that it can take at least six months to get an answer. If you’d like an answer sooner, consulting a tax advisor is a great option.

What's the difference between independent 1099 contractors and employees

Source: U.S. Department of Labor

What happens if you misclassify an employee as a contractor?

Why the fuss over worker classification? Well, if you misclassify an employee as an independent contractor, you can be held liable for paying employment taxes for that employee retroactively. You may also be required to reimburse them for overtime and workers’ compensation benefits. 

Pros and cons of hiring 1099 independent contractors

At this point, you understand the importance of distinguishing between employees and independent contractors. But why would you choose one over the other? Let’s dig into some of the pros and cons of hiring an independent contractor.

Pros of hiring independent contractors

  • More flexibility with payroll and expenses: Since contractors are usually hired for a specific project or length of time, you can better fine-tune your payroll to your current business needs.

  • Reduced expenses overall: Contractors are often less expensive for your business to hire than in-house employees. This is partly due to the fact that you only hire them on an as-needed basis. However, the fact that you don’t have to deal with payroll taxes or benefits can also be a huge cost saving.

  • Project-specific expertise: 1099 contractors often spend all of their working time on a specific type of project—they can be much more specialized than an employee. As such, they can bring a tremendous amount of experience and expertise to a project.

 Cons of hiring independent contractors

  • Less loyalty: Independent contractors don’t usually have the same level of loyalty to your company as an employee. They may be unwilling to work beyond the specific scope of their contract. If they do, they may charge for it. This can be a problem during busy periods if you rely heavily on contractors.

  • Reduced control: Independent contractors are just that—independent. As such, they usually have more autonomy in how and when they work. Normally this isn’t an issue, but it does give you less control over the work and how it’s done.

4 tips to work effectively with 1099 independent contractors

Working with 1099 contractors can be a fantastic way to keep your business nimble and minimize expenses. However, it can also come with some potential pitfalls. To help you navigate these, we’ve compiled a list of top tips for getting the most out of the experience. 

1. Make your expectations clear

First and foremost, you should ensure all expectations are clear to all parties involved. Make sure the contractor understands any stipulations you have for how and when work should be completed and how and when they'll be paid. This will help avoid potential misunderstandings around deadlines or processes as work gets underway.

2. Document all communications

Put those expectations, along with pricing and any other relevant information, into a clear contract and have the contractor sign it. Keep a paper trail of all communications and other interactions—this can be important in the event that a misunderstanding does arise or there’s a question about scope of work. 

3. Keep thorough, accurate records

It’s important, for both tax purposes and legal purposes, to keep accurate records of the contractors you hire and what you pay them. You’ll need to report this to the IRS, and it’s also a deductible expense on your part, so make sure you’ve got your books covered! 

4. Let the contractor do what you hired them to do

You didn’t hire an independent contractor so you could practice your babysitting skills. If you’ve vetted them and they’re capable of doing the job you hired them for—let them do it! You hired them for a reason, after all.  

Find your 1099 sweet spot 

Independent contractors can be a valuable addition to your team without the cost of hiring a full-time employee. They’re cost-effective, flexible, and often highly skilled. However, it’s important to ensure that you classify them correctly to avoid paying back taxes and penalties.

Onboarding and managing 1099 contractors can be time-consuming and complex, especially when you’re doing it for the first time! From collecting W-9 forms to tracking payments and generating 1099-NEC forms at the end of each tax year, it's important to make sure you're doing it right.

That's where Found can help. Found can help you streamline and simplify the entire process: 

  • Onboard 1099 contractors with ease by automatically collecting W-9 information. From the app, you can easily request W-9s from your contractors. Once it’s complete, it will automatically sync with your Found account. If you already have a copy of their W-9, it’s easy to enter it manually.

  • Track payments. When you send a payment to a 1099 contractor, we’ll automatically categorize the payment accordingly and track it as a tax deduction. 

  • Generate PDFs of 1099-NEC forms for contractors whose payments exceed $600. With one click, you can export 1099-NECs for the prior tax year. All you have to do is share them with your contractor and the IRS. 

The best part? Found’s 1099 contractor payment features are available for free!

If your contractor also creates a Found account, they’ll not only get paid instantly—for free—but also get access to the same banking, taxes, and bookkeeping features to help streamline their self-employment income. It’s a win-win!

When you’re self-employed, your time and your finances are limited. That’s why Found is on a mission to make self-employment easier. Say goodbye to the stress of managing 1099 contractors, and focus on the more important aspects of running your business. We believe in doing what you love—which probably isn’t paperwork. Sign up for free today.

The information on this website is not intended to provide, and should not be relied on, for tax advice.

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