1099 Contractors vs. W2 Employees: Ultimate Guide for Practice Owners

Practice owners often have questions about the best way to structure their businesses. One question that comes up a lot is whether to hire 1099 contractors or W-2 employees. In this article, we will discuss the differences between these two types of workers and help you decide which is best for your business.

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1. What is the difference between a 1099 and a W-2 employee?

The main difference between these two types of employees is how they are classified for tax purposes.

The fundamental difference between these types of employment is the forms used for taxes: the W-2 form or a 1099 form. 

W-2 employees are considered “employees” by the IRS and have taxes withheld from their paychecks. 

On the other hand, contractors who are paid via Form 1099 are considered “independent contractors.”

This means:

• That independent contractors are responsible for paying their own taxes and malpractice insurance.
• That the practice does not have ultimate control over their behavior, finances or relationship.
• Independent contractors should not rely on one practice as their primary means of income. (Basically, according to the IRS, there’s no such thing as a full-time independent contractor working at a single practice).

NOTE: This is not legal or tax advice so please consult your lawyer. 

2. How do Benefits and Overtime benefits work?

A key difference between these two types of workers is how benefits and overtime work. W-2 employees are typically given benefits like:

• Health insurance
• Sick days
• Vacation days
• They are also usually entitled to overtime pay if they work more than 40 hours in a week

This is because they are considered “independent contractors” which means they are in business for themselves.

Independent contractors are typically not provided with overtime pay, malpractice insurance and are not eligible for unemployment benefits if they lose their job.

1099 Contractors are expected to absorb these costs as part of their business.

3. The IRS Common Law Test

This test looks at 3 factors to help businesses determine whether or not a worker should be classified as an employee or contractor.

How to Use the IRS Common Law Test to Determine Employee Status

While the test may sound intimidating, don’t worry because it is very straightforward. I’ve got you covered. 

3 Factors The IRS Considers:

• Behavioral – Does the business control (or have the right to control) how a worker does their job?
• Financial – Does the business control how the worker is paid (including expense reimbursement, paid training, etc.)?
• Type of Relationship – Does the employee receive benefits, or paid time off, and is the work performed a key part of the business?

Behavioral Control

Behavioral Control refers to how you, as the practice owner, control how your clinicians or administrative staff do their job. This includes when and where the work is performed, what tools they use, where and how to purchase supplies, and even what order the work must follow to be completed correctly.

The IRS breaks down Behavioral Control into 4 different subcategories to give you a more detailed look at how to categorize your workers.

These subcategories include:

• Type of Instruction
• Degree of Instruction
• Evaulation Systems
• Training

In the graphic below, I outline how both Employees and Contractors fit within these subcategories.

Financial Control

Financial Control refers to whether the practice owner has a right to control the economic part of a worker’s job. This includes expense reimbursement, method of payment (regular salary or project based compensation), as well as opportunity for profit or loss.

Financial Control is broken down into 5 different subcategories in the Common Law Test.

These subcategories include:

• Significant Investment
• Unreimbursed Expenses
• Opportunity For Profit or Loss
• Services Available to the Market
• Method of Payment

In the graphic below, we outline how both Employees and Contractors fit within these subcategories.

Type of Relationship

Type of Relationship refers to how the practice owner and worker perceive their relationship to each other. This includes written contracts that clearly state “employee” or “contractor”, the distribution of employee benefits, as well as the perceived length of your working relationship.

This section is broken down into 4 different subcategories in the Common Law Test.

These subcategories include:

• Written Contracts
• Employee Benefits
• Permanency of Relationship
• Services Provided as Key Activity of the Business

In the graphic below, I outline how both Employees and Contractors fit within these subcategories.

What is The Economic Realities Factor Test?

The Economic Realities Factor Test is a newer way the IRS has created to determine whether a worker should be classified as an employee or an independent contractor.

This test looks critically at if they are really in business for themselves or are dependent on the company at which they contract.  

How to use the Economic Realities Factor Test to determine Employee Status

The factors in the Economic Realities Test are most commonly understood to include the following:

Is the Work an Integral Part of the Employer’s Business?

If yes, the worker is likely an employee.  If the work is tangential to the business, such as a landscaper performing services for an accounting firm, then the worker is more likely a contractor.

Does the Worker’s Managerial Skill Affect the Worker’s Opportunity for Profit or Loss?

If yes, the worker is more likely a contractor.  Contractors manage their own businesses.  Strong managerial skills are more likely to result in a profit; poor managerial skills are likely to result in a loss.  Employees, on the other hand, make money either way.

How Does the Worker’s Relative Investment Compare to the Employer’s Investment?

More investment by the worker means the worker is more likely in business for himself/herself and is therefore more likely an independent contractor.

Does the Work Performed Require Special Skill and Initiative?

Independent contractors tend to be trained and have specialized skills.  Unskilled workers, or those who need more training, are more likely employees.

Is the Relationship between the Worker and the Employer Permanent or Indefinite?

Indefinite, ongoing relationships are likely to be employment.  Fixed project-based relationships are more typical of independent contractors.

What is the Nature and Degree of the Employer’s Control?

The Right to Control Test factors can be considered as a small part of the analysis, but they are secondary to the economic factors described above.

Federal courts tend to articulate the Economic Realities Test using the same or similar factors, but the precise language and factors sometimes differ from jurisdiction to jurisdiction.

So, there you have it! These are the two main tests that will help you determine whether a worker should be classified as an employee or an independent contractor.

4. Can your 1099 contractors work at other practices?

If you’re not sure whether or not your contractors are in violation of their non-compete clauses, you should consult with an attorney. They will be able to advise you on the best course of action.

5. Which one is right for your practice?

However, this is not always the case. Employees also are associated with benefits in terms of loyalty and hard work. Oftentimes, employees are more focused and devoted to your business’s mission and goals.

If there is ever a question in your mind about whether someone should be treated as an employee or independent contractor, it is better to air on the side of caution. To avoid a misclassification, treat those cases as employees. There are no punishments for misclassifying as an employee, but there are consequences for misclassifying a worker as a 1099 Contractor. 

6. How to transition from Independent Contractors to W-2 Employees

Sometimes practices can lose a large number of their staff because they didn’t know how to handle these changes. It is important to communicate clearly what this means for them and why this is benefitting both themselves and the business.

While it may look like their check is getting smaller, they pay less in taxes and get benefits. 

If you are unsure of how to introduce benefits into your practice, simply ask your staff what benefits they most want. Give them options so they have reasonable expectations. You can also stick to your state’s recommended benefit compensation.

Conclusion

Ultimately, it comes down to what makes the most sense for your practice. We hope this article has helped clear up some of the confusion and made the decision a little bit easier for you.