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Scaling Your Business: W-2 Employee vs 1099 Contractor

Congratulations, your business is growing. That means you’re moving away from solopreneur to small business ownership. You’ll need a team to duplicate yourself and begin to automate. However, there are several things to be considered before you venture into your first hire. The first is evaluating whether you’ll need to hire a W-2 employee or a 1099 contractor. There are pros and cons to each option, but first, let us define what they mean.

1099 Contractor

A 1099 contractor is an independent contractor. They are not on your payroll, and you will not have to calculate taxes for their services. A 1099 contractor owns their own business and can be referred to as freelance or self-employed. If you pay your 1099 contractor $600 or more, you are required to report their compensation via a Form 1099, tax for, hence the name, 1099 contractor.

It is essential that you ask the contractor to complete a W9 form before starting any engagement. This form contains all the essential information to be able to issue Form 1099 and report the amount to the IRS.

W-2 Employee

Conversely, the W-2 employee will complete a W-4 form at the start of work so that you for tax withholdings. An employee at the W-2 level is on your company's payroll, which means you are responsible for deducting the required taxes from his or her pay.

However, there is more differences between an employee and a contractor than just reporting income taxes.

Control and Responsibility

When you hire an employee (W-2), you are responsible for their training and development, and their ability to perform the work hired to do. You have more control in managing their work, and your expectations for the work to be performed.

With a contractor (W-9), you have control over the outcome of the work, but not over the way it gets done. The contractor is not your employee, so they do not report to you. They own their own business, so they have full latitude to accomplish the goals and tasks that you set out for them using their own methods. Since they are independent, you are not responsible for their training and development like you would be with an employee.

If you want to hire someone that you want to shape and mold to perform tasks for your business in a particular way, it is best to hire an employee. If you have a variety of tasks and responsibilities that you want this person to perform that is not narrowed down to a specific skill set, you will want to consider an employee as well. A good example might be hiring a marketing manager to execute all marketing activities and the marketing strategy for your business versus hiring a content writer to write specific content for your marketing campaigns. The marketing manager, because their performance is directly connected with how you operate your business, would be a W-2 employee. The content writer is free-lanced, or may own their own business, would be contracted as a W-9 contractor. They, then, would be given specific tasks to complete in tangent with your business’ operations.

Since the work of the content writer is specific and targeted to a skill set, this is an opportunity to hire a contractor if you choose. A contractor gives you the opportunity to hire specific expertise while giving them the freedom to execute the tasks given to them with little concern over supervision and just outcome. Since they are professionals that you have contracted, you do not have to spend much time managing their time or tasks as you would with an employee.

Costs of Employees vs Contractors

The net effect of employees is greater than that of a contractor; it takes more time to train and develop an employee versus a vendor. The vendor is normally a subject matter expertise and requires no training. Employers must match social security and health insurance taxes with those of the employee, in addition to being responsible for other taxes. This does not account for the cost to set up your employee's work environment, whether you choose to use a physical office space or equip their home office.

Conversely, you don’t incur any of these expenses with a contractor, accounting for about 30% in savings. Since contractors are business owners and responsible for their own taxes/expenses, you will not have to incur any of these additional costs for bringing them into your business.

At first glance, it seems that contractors are the natural choice for building your business team; however, there are benefits to hiring employees, especially if you are looking to build a sizable business with a particular work culture.

The ideal approach to scaling your business would be a hybrid approach where you have both employees and contractors on your team. You must evaluate your business needs and what makes the most sense to meet those needs to determine the best resource.

Consider a business partner to help you navigate these waters and make the best choice for your business. VAAS Professionals has over 20 years of experience working with small business owners and guiding them though decisions like this.

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