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The Difference of Getting Paid With a 1099 Verses a W-2

Aug 17, 2007
Whenever a business starts there is always the question of how the people that provide services for the business will be paid. Will those services be performed by employees or will independent contractors be used?

Before the business can determine how to treat payments they need to know and make clear the business relationship. It is important to establish this relationship because an employee has taxes withheld, social security and medicare matched by the employer, unemployment insurance paid, workers compensation insurance paid and often benefits provided. An independent contractor just gets paid. It is a big expense difference.

To determine whether an individual is an employee or and independent contractor, the relationship of the business and worker must be examined. It comes down to does the business have control over what and how a job will be done or do they just control the results of the job. The determination falls into three categories: behavior control, financial control, and type of relationship.

Behavioral Control

Employees are generally subject to instructions about when, where, and how to work. The employer controls when and where the work is performed and what hours the person will be at the job. The person is told what tools and equipment to use, who else can be hired to assist with the work and where to purchase supplies and services. They are told what work is to be performed by a specific individual and what order or sequence to follow. Employees also may be required to receive training by the employer.

Independent Contractors can be hired to do a certain job in a certain place and be completed by a certain time. However, how the job is done is up to the contractor. When the work is performed, what equipment is used, who is hired to assist and where materials and supplies are purchased are up to the Independent Contractor. They also obtain and pay for their own training.

Financial Control

An employee is generally guaranteed a regular wage amount for an hourly, weekly or other period of time, even if the wage or salary is connected with a commission. They may be paid whether work is being performed or not. An employee generally does not have an investment in the company unless there are stock options available. They usually have any expenses they incur for things such as travel, phone, or equipment reimbursed.

An Independent Contractor is not reimbursed for any expenses. They generally have a business of their own or a significant investment in the facilities and equipment used to perform the work. An Independent Contractor is free to offer services to the general public and can take on jobs for other companies or individuals. They generally advertise their services and maintain a home office or visible business location. They generally get hired and paid by the job, usually a flat fee. Although some jobs can be billed hourly. An Independent Contractor can make a profit or loss on the job.

Type of Relationship

An Employee generally signs a employee contract. The employee is generally provided benefits such as insurance, pension plan, vacation and sick pay. Employee's are engaged for an indefinite period of time. They perform activities that are a regular daily part of the business. They fill out an IRS W-4 form that tells the employer how much taxes to withhold. They are not free to do business for other companies and in fact some companies have penalties if they do.

Independent Contractors have job by job contracts or for specific project or periods of time that state they are responsible for their own taxes. They are not provided with any benefits. They fill out an IRS W-9 form telling the IRS that no taxes are required to be withheld.

It is important to determine what kind of relationship from the beginning of your business. If you treat an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that person. Also, if you pay an individual as an Independent Contractor, they do not qualify for unemployment of workers compensation so if they try to collect it, you will want to be ready to verify they are not an employee.

More information about Employees and Independent Contractor is found in the IRS publication 15A.
About the Author
Christopher Anderson is part owner of Lone Peak Business Solutions, Inc. He wants to share his success as a business owner with others who desire to own their own business. He also believes that the economy is stronger with more business owners, and as a result, he is focused on helping business owners succeed.
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