1099 vs W2 Employee | Baron Payroll

1099 vs W2 employee, which is better?

As a business owner, one of the biggest decisions you’ll make is how to classify your workers, and whether to pay them as W-2 employees or 1099 independent contractors. While paying your workers as 1099 independent contractors may seem like a good idea in the short term, it can lead to big problems down the line.

In this article, we’ll take an honest look at the cost differences between paying workers as W-2 employees and 1099 independent contractors, and what it means for your business.

What is the Payroll Tax Burden?

When you put your workers on payroll as W-2 employees, you have to pay the payroll tax burden, which is the extra tax expense to the employer.

The payroll burden is a combination of the 6.2% Social Security tax, 1.45% Medicare tax, state unemployment tax, and workers' compensation insurance.

On average, this typically adds up to about 15% of your employee’s wages, which is a significant expense.

What’s the Financial Impact of 1099 vs W2 Employees?

The financial impact to the employer:

When you pay your workers as W-2 employees, you’re paying their wages plus the payroll tax burden. When you pay them as 1099 independent contractors, you’re only paying their wages.

For example, if you pay a contractor $1,000, that’s the total cost to you as the employer. But if you pay them as a W-2 employee, you’ll also have to pay the payroll burden, which brings the total cost to $1,150.

The financial impact to the employee:

There’s also a financial impact to the employee. For example, as a 1099 worker, if the employee gets paid $1000, their take home pay will be $1000.

However, as a W-2 employee, if they were paid $1000, their take home pay will typically be about $750 because of the withholding taxes.

Additionally, with regard to Social Security and Medicare tax, from the employees’ point of view, they are financially better off getting paid as a W-2 employee.

Why?

Because as an employee, the employer will pay half of the tax amount and the employee will pay the other half. As a 1099 worker, the employee pays both halves of the Social Security and Medicare tax.

Why Does the Government Want You to Pay Everyone on Payroll?

The government wants everyone paid as W-2 employees so they can collect their cut from both the employer and the employee. Collecting taxes from both adds up to a big number for the government.

In our example above, they are getting an extra $150 from the employer (payroll tax burden) and also getting $250 from the employee (withholding taxes). So, on $1000 worth of wages, the government is collecting $400 or 40%.

Also, being paid as a W-2 employee is a requirement for unemployment benefits. So, if your employee is ever laid off, they’ll need to be paid as a W-2 employee to easily collect unemployment.

How Do You Transition Your Workers from 1099 to W-2 Employees?

If you’ve been paying your employees as 1099 independent contractors and want to transition to paying them as W-2 employees, there are a few things you can do to minimize the extra expense incurred from the payroll tax burden.

First, you should explain to your workers what’s going on and educate them on the financial benefits of being paid as a W-2 employee as opposed to a 1099 contractor.

The first big benefit is instead of the employee having to pay both halves of the social security tax (7.65% x 2) at the end of the year when they file their income tax returns, now the employer will pay 7.65% and the employee will have 7.65% withheld from their paycheck. This way, at the end of the year, when they file their income tax returns, the employee will have to pay zero for social security tax because it’s already been paid.

Another big benefit for the employee is every time they get paid, a little money will get withheld for income taxes (federal, state, local). This way at the end of the year when they file their tax returns, they might not have to pay anything extra for income tax, and in fact, might get a refund.

All in all, paying your employees as W-2 employees may initially seem like an extra expense but it’s worth it in the long run.

Also, you’ll be protected from fines and penalties and your employees will have workers comp insurance in case they ever get injured on the job.

Business owners are often shocked to learn that many workers prefer to have taxes withheld from their pay and get less every pay period. Most workers that have been through the hassle of experiencing the pain of paying all the extra money when filing their income tax returns, would much prefer to avoid that. They would rather be a W-2 employee.

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