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1099 vs. W2 Employees: Avoid IRS Trouble With Our Classification Tips! - YouTube
Channel: Fundera by NerdWallet
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Hi, I'm Priyanka Prakash, Senior Staff Writer
at Fundera.
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The difference between 1099 vs. W2 workers
is something that trips up a lot of small
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business owners.
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Unfortunately, if you don't understand the
difference between these two types of workers,
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it could really cost your small business both
legally and financially.
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We created this video to explain the difference
between 1099 vs. W2 and help you keep your
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business in the clear.
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Okay, for starters, why should you even care
about these acronyms, 1099 and W2?
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Well, these are two different kinds of workers
that could be part of your team, and the numbers
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refer to the different tax forms that you
have to send to these workers.
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A W2 employee is a regular staff employee
who's entitled to minimum wage, overtime protections,
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retirement contributions, and other employee
benefits.
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By January 31 of each year, you'll need to
send your W2 employees a W2 form, which shows
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their annual wages, and they'll then use that
form to file their taxes.
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The W2 form will also show any deductions
that you made from that employee’s paychecks
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throughout the year.
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A 1099 worker is not an employee; they're
an independent contractor.
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You're not required to pay an independent
contractor minimum wage or offer them any
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kinds of employee benefits.
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By January 31 of each year, you'll need to
provide your 1099 independent contractors
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with a 1099 form, which they'll then use to
file their taxes.
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So, which is less expensive for businesses:
a 1099 contractor or a W2 employee?
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Businesses often hire 1099 independent contractors
because they're far less expensive for your
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company.
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There's a long list of things that independent
contractors are not eligible for, including
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minimum wage, health insurance, disability
benefits, unemployment insurance, workers
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compensation, sick days, vacation time, and
the list goes on.
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Plus, employers don't have to deduct or pay
payroll taxes on 1099 workers.
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When you add up all these costs, you could
save about 30% by hiring a 1099 independent
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contractor vs a W2 employee.
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But, how do you know whether to hire a 1099
contractor or a W2 employee?
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And how do you know how to classify your workers?
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Once you've hired enough employees, classification
is something that you can tell just from the
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circumstances.
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However, if you're on your first few employees,
it’s harder to tell the difference between
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a 1099 vs W2.
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Here are three questions to ask yourself when
figuring out how to classify your workers.
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The first question has to do with control.
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Do you have control over what the worker does
and how the worker does their job?
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For example, let's say you hire Lila to design
a website for your business.
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If you tell her exactly what computer to use,
what web builder to use, and what hours to
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work each day to get the job done, it's pretty
fair to say that Lila is a W2 employee.
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On the other hand, if you simply give Lila
an overall vision for your website, and let
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her implement that however she prefers and
on our own time, you have a better case that
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she is a 1099 independent contractor.
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The second question to ask has to do with
financial aspects of the job.
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Do you control the business and financial
aspects of the worker’s job?
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For example, let's say you hire Bradley to
provide marketing help for your business.
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You provide him with a desk, a computer, and
you tell him that you'll reimburse him later
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for his cab ride to a local marketing conference
that you'd like him to attend.
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Since you're providing Bradley the tools that
he needs to do his job and controlling how
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he'll be paid, Bradley seems an awful lot
like a W2 employee.
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On the other hand, most independent contractors
work offsite on their own time, and they don't
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have required obligations on behalf of the
company, such as attending a conference.
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And the last question to ask yourself is sort
of a catch all question that reflects on the
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type of professional relationship.
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Does the worker receive employee-type benefits,
and is the work performed central to the business
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to success.
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Assume you hire Judy to clean your office
every weeknight for an indefinite period of
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time.
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She brings her own cleaning supplies, but
she also checks in with you when she needs
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to take time off or take sick days, and you
give her some extra pay each month to help
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provide health insurance.
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This looks very much like a W2 employee relationship.
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Independent contractors don't receive employee
benefits and usually perform one-off or temporary
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services for business.
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After considering each of these factors, if
you're still confused about a worker’s status,
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your best option is to file Form SS-8 with
the IRS.
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If you file this form, IRS Lawyers will actually
look at the specific details of your business's
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situation and tell you whether your worker
is a W2 or a 1099 independent contractor.
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Just be aware that getting back a decision
from the IRS can take up to six months, which
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could delay your hiring plans.
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So, what if you accidentally call a W2 employee
a 1099 contractor?
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Seems like an innocent mistake, but you might
end up paying in big price.
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An estimated 3.4 million people are misclassified
each year as independent contractors when
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they're actually W2 employees.
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As you might guess, the IRS does not look
kindly on these kinds of misclassifications.
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Here are the fines and penalties you're looking
at for misclassification.
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The first is fines and back taxes from the
IRS, including a $50 fee for each W2 form
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that was not filed, 1.5% of the employee’s
wages, 40% of the employee’s FICA (social
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security and medicare) taxes, and 100% of
the employer’s matching FICA taxes.
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You also have to pay a “failure to pay taxes”
penalty, which is equal to 0.5% of the unpaid
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tax liability for each month that you misclassified
the worker, up to 25% of the total tax liability.
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The second problem you're looking at is back
benefits.
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The worker can claim health insurance, overtime,
retirement contributions, and anything else
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that an employee would have been entitled
to during the period of misclassification.
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The final problem has to do with reputational
issues.
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A lawsuit from an employee can result in poor
publicity.
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In extreme cases, if the IRS suspects fraud,
criminal penalties are possible.
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The IRS might also choose to audit your business.
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Of course, none of this is meant to scare
you, but it should serve as a reminder not
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to take any shortcuts when classifying your
workers, and if there's any doubt, don't forget
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to file Form SS-8 with the IRS, and they'll
help you out in determining your worker’s
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status.
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So, who should you hire ultimately: 1099 independent
contractors or W2 employees?
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Well, this depends very much on the type of
work that you'd like the person to do.
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Someone who's doing regular, ongoing work
that's central to your company's success is
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typically a W2 employee.
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This is especially true if you set their hours,
provide the tools they need to do their job,
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and control their working conditions.
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For example, if you own a restaurant, sorry!
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Your waiters and cooks are W2 employees, not
1099 independent contractors.
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Someone who's truly an independent contractor
is their own small business owner.
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They can complete a project for you, but they'll
set many of the terms themselves.
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Hiring a 1099 independent contractor is a
good option for one-off projects like website
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design, bug fixes, or your annual tax preparation.
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Okay, everyone.
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That's it for 1099 vs. W2 workers.
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Now, all you have to do is go out and hire
a great team for your business.
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For more information on hiring and other small
business insights, head over to funder.com/blog,
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and subscribe to our YouTube channel for more
videos.
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Thanks for watching, everyone.
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