1099 vs. W2: A Breakdown for Freelancers

The end of the year means every company you’ve worked for in the past year will soon to be sending out your tax forms as April 15 begins to loom closer. If you’re a freelancer, chances are you’re going to get a lot of different returns from a lot of different clients. The two primary forms are W2s and 1099s – but what’s the difference, and which makes the most sense for you and your clients when you agree to work for them?

Breaking Down 1099s

The 1099 form we’re talking about is formally known as a 1099-MISC and means miscellaneous income that you’ve accrued during the year. If you compare 1099 vs. W2, the simple shortcut to remember the difference is that the W2 is for wages from a full-time position where you’re receiving benefits and a 1099 is for income from places like freelance or contract jobs. You’ll need one for any job in which you earned at least $600 during the year. There are plenty of other types of 1099s you can receive for other purposes: 1099-DIV reflects money you’ve received from stock dividends; 1099-INT is for interest earned from investments; 1099-G is for government payments like unemployment; and 1099-R is when you receive money from a retirement account.

Breaking Down W-2s

If you’ve ever had any job where you’re working more than 20 hours a week, then you’ve earned yourself a W-2, whether that job was scooping yogurt at the mall or being the sports editor of the local newspaper. The W-2 shows how much tax has been withheld from your paycheck over the course of a year. Every employer has to report employee earnings to the IRS, and the W-2 is the record of those earnings.  What’s the biggest difference between a W-2 vs.a 1099? The simple answer is that your employer takes out holdings when you have a W-2: that is, social security and Medicare (FICA) taxes. While it stinks to have these things taken out of your paycheck, take heart in knowing that your employer is paying for 50% of both of them.

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What’s Best for Freelancers? 1099 vs. W2

One of the toughest tasks of being a freelancer is taking care of all the things that an employer would normally do. Notably, this includes the automatic withholdings for things FICA taxes along with 401(k) contributions, paying for healthcare premiums, and other perks like discounts on gym memberships or commuter costs. In addition, employers take out an estimated portion of every employee paycheck for the purpose of paying federal income tax.
Let’s take a look at two different versions of the same job to determine what makes more sense for you, a W2 or a 1099.
You’re a freelance technical writer and you get hired by a past client to perform software documentation on their in-house system. They are about to merge with another company and have nothing in written form on how to use their own software, which will be vital for all the new employees.
Your client gives you two options: come to work at their office a few days each week or have the software and other data sent to you via a flash drive to upload onto your own computer and work from home.
If you choose to go on site and you are at the place of business for more than 20 hours a week for a job lasting at least three months, you should ask to fill out a W-2. Regardless of your hourly salary, you’re going to be making a lot of money over the next three months or more, and it makes a lot more sense to have your income tax and FICA deductions taken out up front, otherwise you’ll be sending big checks to the IRS at the end of every quarter. In addition, since you’re on-site, you’ll be acting like a full-time employee – using their kitchen, their water cooler, their pens and pencils, computers and printers, coffee machines, and staplers.
If you choose to work from home, the 1099 is the way to go. You’ll get all of your promised salary via check or electronic payment, and it will be up to you to pay the appropriate amounts to the government as a self-employed worker. However, you are entitled to write off some of your work expenses when you’re working from home. For starters, you can deduct a percentage of your mortgage and utility bills that correlates with the amount of square footage your home office represents of your total home. And all that printer paper, staples, and postage stamps that you’re buying to keep your business going? All 100% tax deductible, as are your health care premiums and a host of other items.

What’s Best for Employers? 1099 vs. W2

When you’re the one running the business, balancing the books, and (hopefully) staying in the black, the notion of whether you need employees to fill out a 1099 or a W2 really depends on what your motivations are and what stage of its lifecycle your company is in. What does that mean? Let’s consider:
You are the owner of a small but successful graphic design firm located in Houston, Texas. Between the oil companies, the tech firms, the massive market for advertising, and the healthcare industry in town, you’re never hurting for clients.When things are really hopping, your four graphic designers are pressed to their gills and often complain that another person would really ease their load.
So you put an advertisement for a graphic designer. You’re hoping for someone young and with little experience that you can hand the more simple jobs off to, allowing your seasoned employees to handle the more complicated, lucrative stuff. Envisioning the job role is easy, making it a reality is a bit more involved and requires some tough decision making.
If you hire the new employee solely as a contractor/freelancer working under a 1099, there are plenty of positives. For starters, you are only adding the cost of their salary to your business expenses, nothing more. If you’re paying them $1,000/week, or roughly $50,000/year. If you’re adding a full-time employee who makes $50,000/year in salary, the total cost of adding them is actually closer to $66,000.  That’s a lot of extra money to spend on someone without any guarantee that they’ll do the job you want done the way you want it done. New hires are always speculative. Hiring someone as a contractor using a 1099 also means you can control the number of hours they work per week. The week before Christmas and the week after are dull for most small businesses, so you can drop a contractor to 5-10 hours those week, then bump them back up to 30 hours when the New Year begins.
However, there is a flip side to choosing to make your hires into W2 employees rather than 1099 contractors. People who are getting steady wages and benefits are generally more committed to their jobs because they are seeing them as stable. When you’re a contractor, somewhere in your head you know that this job is temporary and that when it ends, you’d better have something else lined up replace it. 1099 employees are going to be looking for the next thing while they’re working for you, and if they are in work agreements that can be broken at any time by either party, they’ll be much more apt to quit working for you as soon as something that looks better comes along. On other hand, giving an employee a W-2 means you’re interested in their services for the long haul, and that you’re willing to share the load with them when it comes to paying their taxes. This is a significant step toward cultivating a culture that you want the employee to be a part of, and allows them to feel like part of your organization, not just someone who comes to work there a few days a week.

So, Do I Need a 1099 or W2?

It’s not a cop-out, but the answer is: It depends on your situation. Quite honestly, it’s a dialogue that employers and employees should have between themselves when they are hammering out details of a working agreement. Usually employers are more likely to take the lead, as they decide if employees should be hired on a contractor’s terms or as a full-time employee, but if you’re the one bringing the talent to the table, don’t be afraid to voice our opinions on whether it makes more sense to fill out a W-2 vs. a 1099.