You’ve been hard at work building your small business and now it’s time to bring on some additional help. Great! Whether you already have a couple of part-timer or you’re starting from scratch, you have options.
You can choose whether to hire new team members as regular employees for whom you withhold taxes and pay worker’s comp insurance. Or, you can contract with them as 1099 workers. However, there is a lot more to it than just how to pay taxes. Learn the implications of each arrangement to know which works for your company.
Basics of 1099 and W-2 Classifications
Whether you call them freelancers or independent contractors, 1099 workers are self-employed. You should create a contract with them just as you would a vendor or business partner. The two of you might agree upon a set period of time for the contract, renewing as necessary. You do not withhold or pay taxes on their behalf, but you typically have less control over how and when they work. For example, an independent contractor might work remotely at least some of the time, and can set their own hours assuming they complete all contracted work.
A W-2 employee begins employment by filling out form W-4, Employee’s Withholding Allowance Certificate, with the IRS. The employee uses the form to designate how much of their paychecks they want withheld for taxes. You can pay a W-2 employee an hourly wage or annual salary. It is generally expected, though not required by law, that you also offer benefits to these employees. At minimum, you typically offer a certain number of paid days off for holidays and/or vacation and personal time. In exchange, you gain more control over how and when the employee works.
Hiring, Firing, and Other Considerations
To find a new employee, you place an ad the same way for either type of employee. It’s a good idea to make it clear if you are seeking an independent contractor. If you say nothing, applicants will assume you’re seeking an employee.
You can draft a contract with a 1099 employee at any time and for any length. You can agree to pay based on time or workload. However, you must honor the contract, which means you cannot let someone go without warning. By contrast, you can release a W-2 employee at anytime for any non-discriminatory reason.
You will need to provide computers, business cards, or any other pertinent equipment to all W-2 employees. Independent contractors, on the other hand, cover their own costs for such things. Their contract may spell out certain reimbursement costs. For example, you might agree to reimburse them for gas or other travel expenses associated with your business.
Setting up a payroll system can seem daunting at first. There are plenty of software products on the market to help you administer payroll and set withholdings. If you plan to hire many W-2 employees, you should consider a full- or part-time HR person to handle this for you. You need to make sure you handle everything legally and avoid and real or perceived discrimination.
Mis-classifying employees can incur penalties from the IRS. They could require you to relinquish back pay or back taxes for as far back as three years. An employment attorney can guide you in making the right choices.