Business growth often means hiring employees. Since there is no manual for running a business, it can be difficult to know what type of employees to hire. Failing to pay an employee properly or issue the correct tax form can also have hefty financial ramifications. To help avoid any legal or financial issues knowing the difference between a 1099 versus a W-2 employee is a must.

1099 Workers

1099 workers are a tricky subject in terms of employment. A true 1099 worker is considered a subcontractor or Independent Contractor. Subcontractors are not considered employees of a business. A subcontractor is typically a person or company hired to fulfill a temporary offsite role. Subcontractors can also be people like virtual administrators, IT or an answering service that perform the same functions for many businesses. These types of subcontractors are often self-employed, sole-proprietors or small businesses that offer one specific service.

1099 workers do not have payroll taxes withheld from payments for services. Payroll taxes are not withheld because 1099 workers are required to remit their own payroll taxes. Employers do not have to pay employer matching taxes on 1099 earnings.

W-2 Workers

A W-2 worker is the typical worker a business hires to help in the day to day operations of a business. If a worker is on-site meaning that they work every day at the physical business location, the worker is W-2. Other ways to know if a worker is a W-2 employee:

  1. Employee works in a physical location used for business operations.
  2. Employee is solely employed by one business.
  3. Employe works from home and fulfills the same role, daily or weekly that is vital to the day to day operations of the business.
  4. Employee is not self-employed.
  5. Employee is the owner of an S-Corp or single member LLC.

Employers are required to pay employer matching taxes on employee wages when an employee is a W-2 worker. W-2 employees are also eligible to receive benefits like paid time off (depending on the state) and disability, worker’s compensation and unemployment.


Maintaining employees can be costly. When employing an on-site worker, employers are required to carry coverage like worker’s compensation that cover an employee if they are injured on the job. Employer matching taxes can also add up. Employers are required to match the funds withheld from employee paychecks for social security and medicare taxes. Employers are also required to pay additional state payroll taxes which are a direct expense to the business. Paid time off can sometimes be required by the state. For these and other reasons, some employers will try to classify employees as 1099 workers. There are many different ramifications for employers that misclassify workers. Employers send reporting quarterly to state and federal entities. Business also have to file payroll and income tax returns. Any independent contractor or subcontractor with earnings of more than $600 in a calendar year is required to receive a 1099 at year end. W-2 workers will receive a W-2 at year end showing earnings and taxes withheld.

Common issues that employers that misclassify employees will encounter:

  1. Employee does not realize they have been classified 1099. Sometimes employees are unaware of the consequences of filing 1099, even if an employee asks you to classify them as a 1099 employee. Some employees only hear that they will not have taxes deducted from each paycheck. Unfortunately, the old adage nothing is certain but….is completely true. It is a terrible surprise to find that taxes are still due on an entire year’s worth of earnings at tax time.
  2. Employee reports employer to state authority. Not all employee relationships end well. If an employee feels mistreated or angry they may lash out. All states have an employment agency that helps maintain employee/employer relations. If reported to a state agency, the agency may decide to audit your payroll records. If it is determined that a business failed to report W-2 employee wages, the business may be subject to payment of payroll taxes, penalties and interest. It should also be noted that the interest and penalties can go back years even if an employer is reported years later.
  3. Employee is not eligible for disability or unemployment when needed. In light of recent world pandemic events, benefits like unemployment are critical. Additionally, a worker can be injured on the job any time any place. Misclassifying an employee can cost the employee necessary benefits during difficult times and the result…see #2. An employee reporting an employer is not the worst thing that can happen. An employee can sue at a later date for any number of reasons. The end consequences of a lawsuit can be devastating to a business and the owners of a business.
  4. Loopholes close and laws change just ask Uber. Because Uber’s drivers are considered independent contractors, Uber saves millions per year in insurance and payroll tax costs. Uber drivers are also responsible for things like insurance, fuel and maintenance of their vehicles. Whereas a taxi company would be responsible for all of the above, Uber avoided this by deeming their drivers to be independent contractors. Recently the state of California sued Uber and Lyft. The result of this landmark lawsuit may cause sweeping legislation across many states to ensure that employers don’t abuse 1099 loopholes.
  5. Overpaying taxes to the state and Fed. While it does not happen often, an employer may misclassify an employee in the other direction. Paying a subcontractor or independent contractor as a W-2 employee benefits only the subcontractor.


When To Incorporate

You may be wondering if it is time to take your small business to the next level. Maybe you’ve been self-employed and your business has grown. Maybe you secured funding for your business venture from investors. Maybe you’ve been freelancing and want to expand operations. Knowing when to incorporate can save a lot of headache and unnecessary expense.

Cutting Costs

Being a self-employed owner is often expensive. Paying for costs out of your pocket can add up. Maybe it seems like incorporation would save you money. It doesn’t. Incorporation often makes the cost of running a business go up. State filing fees can range from the 100’s to the 1000’s of dollars depending on your state. Incorporation also puts you on the radar with many state and federal agencies making you liable for taxes and corporate compliance.

Who is Liable?

This is a good question to ask if your business operations involve others. When you are self-employed and are the sole employee of your business you are responsible for only yourself. When you begin hiring employees, open a physical location or start taking on investors, you become liable for others involved in your business as well. When you incorporate you create an entity outside yourself that is liable for your business operations. Any assets like buildings and equipment for your business are owned by your business. Your personal assets such as houses and vehicles remain your own. If someone sues your business, your personal assets are protected and remain your own so long as your corporation is compliant. If you are concerned about liability, hiring W-2 employees or taking on investors, incorporation is a good way to protect yourself and your assets.


When you incorporate your business is required to file its own tax return with the government and the state you operate in. While this is an additional expense, filing taxes as a corporation can also save you money. If your self-employed business is making more than $100,000.00 per year, it may be time to look into incorporation. As a self-employed business owner you are subject to self-employment taxes. Self-employment taxes mimic corporation taxes which can be higher than corporate taxes depending on your income and deductions. You may also be able to deduct more as a business than you can as self-employed. Certain business expenses are not tax deductible unless you file a corporate tax return.

No Longer Flying Solo

If you are taking on a business partner incorporation is probably the way to go. Becoming a corporation, LLC or General Partnership will protect all people involved in the business. Incorporation also involves detailing the percentage ownership and corporate responsibility of each owner. Having a partnership agreement in place does not require incorporation but is almost always a part of incorporation. If you will be accountable to investors, especially investors that own part of your business, incorporation will help protect your personal assets. Keeping your assets separate from your business assets is essential to your personal financial health.

If you have more questions about incorporation and whether it is right for you, feel free to call us at 1-800-572-4419 for a quote and free consultation. You can also email us at [email protected].

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