Many small business owners have stories about the days when they ran the entire operation themselves. As soon as growth begins, however, hiring employees becomes a necessity. For businesses of any size, there are two options when it comes to hiring: 1099 contractors or W-2 employees.
The terms “1099 contractors” and “W-2 employees” refer to the tax forms each type of employee will need. 1099 contractors are workers you hire on a contract (usually temporary) basis, while W-2 employees are those you hire and add to your business payroll. At the end of the calendar year, businesses issue 1099 forms to contractors detailing the wages paid to those contractors, and W-2s to employees showing employees’ wages and the taxes withheld from those wages.
Hiring contractors to perform the work of a full-time employee can be considered tax fraud. It’s always a good idea to consult with a lawyer or employment professional in your area to determine which approach is right for your business.
As you build your workforce, here is the key information to keep in mind:
First, some of the advantages of hiring 1099 contractors:
- You save money. When you hire freelancers or consultants, they pay all of their own taxes, taking the burden away from you. You also save money on workers compensation insurance, health care and other benefits, and perhaps even wages if the worker is remote.
- You gain flexibility. You can sometimes think of 1099 contractors as “on demand” workers, or those who are available to help only when it’s most needed. For example, if you have a busy month or two on the horizon, it might be better to hire some temporary work to help fill gaps as needed. Many retail businesses do this during the winter holidays.
- Contractors are (generally) easy to manage. Since these folks typically work on a temporary contract basis, they’re often very motivated and eager to show you they have what it takes to become a full-time employee.
- You’re legally protected. Labor laws for 1099 contractors are not as strict as they are for W-2 employees, which means it’s much less likely you’ll ever get sued. In addition, since you’re the one writing the contract, you can include favorable clauses that allow you to move on should the freelancer not be a good fit.
While saving money is always an attractive option for small business owners, utilizing 1099 contractors comes with a handful of drawbacks to be aware of, including:
- Contractors could affect chemistry. If you have a regular staff of W-2 employees, any contractors you hire may not feel like a part of the team. This could lead to communication issues, particularly at the beginning of a contract.
- Hourly rates may be higher. The adage “You get what you pay for” definitely applies here. Many contractors are very skilled and qualified, but that will be reflected in their hourly wage. Less experienced workers might be cheaper, but the quality of work may suffer as a result.
- Contractors are not always as reliable in a crunch. If a situation arises and you need workers outside of usual work hours, it can be harder to depend on contractors because they may have other clients or have already fulfilled their agreed-upon hourly quota.
Your W-2 employees are those who are on your payroll, whether they work full- or part-time. Having a dedicated staff is great for these reasons:
- Employees provide stability. As your company grows, employees will improve their skills and eventually learn enough to be promoted to manager or supervisor positions. This opens the door for a new wave of employees, helping your business become stronger. That’s not the case with 1099 contractors.
- Employees are often more reliable. In most cases, W-2 employees understand that their job stability is on the line and depends on their performance. They’re more invested in your business than a contractor typically is, and their work may reflect that.
- It helps in recruiting. Many workers prefer the stability of a W-2 position over a contract role, and these folks will be more enticed when such a job at your business becomes available.
- Your team becomes stronger. When you have a staff of W-2 employees that work together regularly, they’ll develop camaraderie over time that can boost morale and ultimately performance.
As with most things in business, hiring W-2 employees comes with potential negatives as well:
- You’ll spend more money. As opposed to saving money on things such as taxes and benefits when it comes to contractors, you will have to pay for those things when you hire W-2 employees.
- Onboarding may be time-consuming. When you hire a new employee, it could take time for you to train them and for them to get fully up to speed. If you need experience and quality work right away, plugging in a qualified contractor might be a better option.
- Parting ways is more difficult. When you hire a contractor, it’s understood that their tenure will end when the contract is complete. But if you need to cut a W-2 employee due to performance or budget, things could become a bit more tense and uncomfortable.
- You need to withhold taxes. Unlike simply cutting a check to a contractor and letting him or her take care of the tax obligations, any wages reported on a W-2 need to have the appropriate federal, state and local taxes withheld. (In most cases, a professional payroll service can help with this crucial aspect.)
Exempt vs. non-exempt employees
Another consideration when assembling your staff is the difference between “exempt” and “non-exempt” employees. These terms refer to those who are eligible to work overtime (and therefore earn overtime wages) and those who are not. Exempt employees are not eligible for overtime wages, hence the name. Non-exempt employees are entitled to overtime wages for overtime hours.
It’s always best to check with a legal professional to make sure you understand the laws in your state. That said, here is typically what’s required for an employee to be considered exempt as of 2018:
- Exempt employees must be paid at least $47,476 annually (or $913 weekly).
- They must be paid on a salary basis, as opposed to an hourly wage.
- They must perform “exempt” job duties, which generally means managerial responsibilities.
Non-exempt employees can be extremely costly if they work overtime hours, but again, be sure to check with a professional to figure out where you and your employees stand.
Which is the best type of employee for you?
Deciding which types of employees to hire will always depend on a number of factors, including the type of business you run, the amount of help you need and the situation you’re in. A mixture of both 1099 contractors and W-2 employees is often the way to go.
For example, if you run a food truck or a small restaurant, a dedicated staff of two or three W-2 employees might be sufficient. But if you run into times of the year that are busier than normal, such as spring break or during summer events, you may want to augment your staff with a few contractors to help ease the load.
Whether you hire a 1099 contractor or a new W-2 employee, it likely means your business is growing. Each type of worker has its own advantages and disadvantages, so try to choose the option that best fits your current situation and will help you meet your long-term business goals.