Choosing Between 1099 and W-2 Workers: A Guide for Employers

As a business owner or professional, it is essential to determine how the services outlined in your agreement will be taxed and accounted for. This decision affects several key areas, including taxability, compliance, worker classification, benefits eligibility, and reporting obligations. In this article, we’ll explore these factors in detail for 1099 and W-2 workers so you can make a well-informed and strategic decision. 

Common law classification rules

Below are the factors that indicate whether a worker is an employee or an independent contractor. 

Behavioral: Does the company have control or the right to control what and how the worker does his job? 

Financial: Does the owner control how workers are paid, reimbursed, or provided with tools/supplies? 

Type of relationship: Are there any employee benefits (e.g., Pension plan, Insurance) Provided by the employer? 

All the above factors must be weighed to determine the relationship between a business and a worker. No one rule of thumb decides the same. Even after considering all the factors, it is still uncertain whether a worker is an employee or an independent contractor.  

Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) can be filed with the IRS by the business or the worker. IRS will review the same and officially declare the status, which might take about 6 months (approximately). Time Being the essence, it is advisable to consult an experienced accountant for reliable advice. 

Let’s have a look at each of the scenarios separately. 

Independent Contractors 

Form W-9: If it is determined that the person will be treated as an independent contractor, the initial step is to have them fill out Form W9. The form has the correct name and Taxpayer Identification Number on file (must be stored for four years for future reference) and ensures accurate information is filed in form 1099 (refer to the point below). 

Form 1099-NEC: Payers must use this form annually to report the payments during the year to the contractor during business. The information in form W-9 refers the contractor to the IRS with the correct name and TIN. This form must be filled out when the yearly payments exceed $600. Certain exceptions are listed in the instructions for the form; in those cases, the form is not to be filed. 

Accounting Implications and Penalties for Misclassification: There is no requirement for payroll software or system to be in place to process the payments to the contractors. The payments will be recorded as ‘Contractor/Subcontractor Expenses’ in the Profit and Loss Account. It reduces the payroll costs for the businesses. However, suppose an employee is misclassified as a contractor without a reasonable basis. The company can be liable for the worker’s employment taxes in that case. (Refer to Internal Revenue code section 3509 for more information). 

W-2 Workers 

Form W-2: The ‘Wage and Tax Statement’ contains information related to earnings, tax withholding, benefits, etc. Employers use it to report all required information about the employee to the IRS annually. A copy of the form is shared with the employee by the 31st of every year. It helps the employee to file the taxes accurately and determine whether they owe taxes or are entitled to a refund. 

Employment Taxes: Employment taxes play a crucial role in an employer-employee relationship. Various taxes include Federal Income tax, social security tax, Medicare tax, unemployment tax, etc. The employer is responsible for deducting and depositing taxes and promptly deducting part of the taxes with different authorities. 

Reporting Employment Taxes: The employers will file Various returns to report the taxes withheld and paid. Please refer to the list below:  

• Form 940 is used to report Employer’s Annual Federal Unemployment (FUTA) Tax Return 

• Form 941 is filed to report the Employer’s Quarterly Federal Tax Return 

• Form 943 is for Employer’s Annual Federal Tax Return for Agricultural Employees 

• Form 944 is for Employer’s Annual Federal Tax Return 

• Form 945 is for the Annual Return of Withheld Federal Income Tax 

Accounting and other Implications: Hiring W-2 employees comes with accounting responsibilities, which are more complex than accounting for independent contractors. 

Payroll software: Businesses are advised to establish payroll systems or software to accurately manage wage payments, withholding, and taxes. Some prominent software the businesses use are ADP, Gusto, Paychex, Rippling, etc.  

Software Integration: To accurately account for gross pay, withholdings, FICA contributions, Bonuses, and expense reimbursements, payroll software must be integrated with accounting software. 

Payroll taxes liabilities: The employers’ share of taxes (6.2% Social Security and 1.45% Medicare) taxes are to be matched by the employer. Employers also have to pay SUTA and FUTA on a timely basis. These must be recorded as ‘Payroll Taxes’ expenses in the Profit and Loss Account. 

Labor Law Compliance: Businesses are required to adhere to the changing labor laws. The labor laws make sure that the interests of employees are safeguarded. Also, tracking minimum wages, overtime, paid time off leaves, etc., is required depending on the applicable state laws. 

Read Also: Understanding Share-Based Payments: Types, Accounting, and Payroll Tax Implications 

Conclusion: 

Hiring a contractor is often the better choice for short-term or project-based work, when you need specialized skills, want to manage costs, aren’t ready for full-time staff, or need support for remote or international tasks that require more flexibility. 

In contrast, bringing on a W-2 employee is ideal for long-term, consistent roles where you need more control over how work is performed, the position is full-time, or you plan to offer benefits and build long-term loyalty. 

Whether you choose contractors or employees, KMK offers end-to-end support—from onboarding and payment processing to compliance management and accurate accounting. Contact us today to ensure your workforce decisions are both strategic and compliant.