1099 Contractor Versus W2 Employee: You Need To Know the Difference

The current labor market is a challenging one. There are no two ways about it. Wages are up, talent is scarce, and small business owners are being forced to get creative with their labor acquisition strategies. When faced with such a dearth of interested and engaged job seekers, many organizations are considering, perhaps for the first time, contracting out some or all of their positions. While contractors are often seasoned professionals who wield formidable skills, as an employer it is vital to understand the difference between a 1099 contractor versus a W2 employee. Make no mistake. The decision on which type of worker to hire is not an arbitrary one and misclassification can cost businesses dearly.

Even prior to the pandemic, many businesses were increasingly supplementing or replacing their standard employment model with contract workers. There are undeniable benefits to this approach. Businesses get seasoned workers and usually save money in the process. They simply pay for the work they need performed when they need it. No pricey health insurance, no paid time off, no payroll taxes.

So what business owner in their right mind wouldn’t just hire contractors to do the work?

Turns out, there are some pretty strict federal and state rules governing what defines a 1099 contractor. It all boils down to how much control and direction a business has over a person’s performance and work product.

If It Quacks Like a Duck

There is an old familiar adage when it comes to classifying 1099 contractors versus W2 employees. If it looks like a duck and quacks like a duck, it’s a duck. Say you hire a contractor to cover a certain workload, but you require that person to clock in at a certain time, you provide them a company computer, you dictate when they break for lunch, you insist they wear a company uniform, you make them attend mandatory meetings, and you require them to check in with a manager. You better watch out because you just misclassified an employee as an independent contractor.

True contractors have immense control over how they perform their jobs. Consider a painter. One would never tell a painting contractor what type of overalls to wear, what size paint brush to use, when they can break for a meal, or how much tape to use. That painting contractor has control over all these aspects of the way they run their business and perform their services.

It gets murkier when contractors are working inside your business and even perhaps alongside your W2 employees. Which brings us to another important point. If your 1099 contractor is essentially performing the same function under the same guidelines as a W2 employee of yours, chances are you have misclassified them.

Why Does It Matter?

Misclassification harms workers who are entitled to the fruits of being a W2 employee and also gives employers undue financial benefit at the expense of the misclassified labor. Contractors generally must pay the entirety of related income tax, Medicare, and Social Security taxes. Were that contractor instead an employee, the employer would be responsible for a good chunk of that tax burden, not to mention overtime wages and other benefits.

Liability for Misclassification

Misclassification can cost businesses serious money. Both private and class action lawsuits are on the rise:

• Just this month a Florida federal court ruled that an eldercare home healthcare worker was misclassified as a contractor. The worker is now entitled to three years of unpaid overtime wages and liquidated damages equivalent to twice the unpaid wages.
• In February the US Department of Labor announced it recovered $139 thousand in overtime back wages and liquidated damages from a cement-cutting business for 21 employees misclassified as independent contractors.
• In October 2021, an energy land service company agreed to pay $43 million in back wages to more than 700 misclassified employees in Pennsylvania, which ultimately drove the business into bankruptcy.

It is estimate that up to 30 percent of employers misclassify employees as independent contractors. And there are new big-buck lawsuits being settled every day.

As the contractor misclassification issue continues to surface and workers become increasingly aware of their labor rights, business owners would be wise to familiarize themselves with state and federal rules defining employment - or risk facing some pretty substantial penalties.