1099 Contractors vs. W2 Employees:

Ultimate Guide for Practice Owners

This is the guide for practice owners who are trying to figure out good hiring practices!

So if you want to learn the nuances of the employee vs independent contractor relationship, you’ll enjoy the actionable tips and information in this new article.

Let’s dive right in!

Launch Counseling Private Practice

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.

This article was inspired by this podcast on The Group Practice Exchange Podcast covering independent contractors and employees

 

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.

TIP: Make sure to track records (based on your state) to ensure workers are being paid fairly and are given overtime pay, if needed.

On the other hand, contractors are not typically given these same benefits because they are not protected by the Fair Labor Standards Act (FLSA).

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.

 

What is the 20 Factor Test Used by the IRS?

The 20 Factor Test is used to help the IRS determine whether a worker should be classified as an employee or an independent contractor. This test looks at 20 factors including how much control the employer has over the worker and whether the worker is paid on a regular basis.

How to Use the 20 Factor Test to Determine Employee Status

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

INSTRUCTIONS

A worker who is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee.

SERVICES RENDERED PERSONALLY

If the Services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results.

SET HOURS OF WORK

The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control.

ORDER OR SEQUENCE SET

If a worker must perform services in the order or sequence set by the person or persons for whom the services are performed, that factor shows that the worker is not free to follow the worker’s own pattern of work.

PAYMENT BY HOUR, WEEK, MONTH

Payment by the hour, week, or month generally points to an employer-employee relationship. Payment made by the job or on straight commission generally indicates that the worker is an independent contractor.

REALIZATION OF PROFIT OR LOSS.

A worker who can realize a profit or suffer a loss as a result of the worker’s services is generally an independent contractor, but the worker who cannot is an employee.

MAKING SERVICE AVAILABLE TO GENERAL PUBLIC

The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.

INTEGRATION

Integration of the worker’s services into the business operations generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, this indicates an employee.

HIRING, SUPERVISING, AND PAYING ASSISTANTS

If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status.

DOING WORK ON EMPLOYER'S PREMISES

If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere.

PAYMENT OF BUSINESS AND/OR TRAVELING EXPENSES

If the person or persons for whom the services are performed ordinarily pay the worker’s business and/or traveling expenses, the worker is ordinarily an employee.

SIGNIFICANT INVESTMENT

If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees, that factor tends to indicate that the worker is an independent contractor.

RIGHT TO DISCHARGE

The right to discharge a worker is a factor indicating that the worker is an employee. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer’s instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications.

TRAINING

Training a worker by requiring an experienced employee to work with the worker, by requiring the worker to attend meetings, or by ensuring services are performed in a particular method or manner.

CONTINUING RELATIONSHIP

A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists.

FULL TIME REQUIRED

If the worker must devote substantially full time to the business of the person or persons for whom the services are performed it impliedly restricts the worker from doing other gainful work. An independent contractor on the other hand, is free to work when and for whom he or she chooses.

ORAL OR WRITTEN REPORTS

A requirement that the worker submit regular or written reports to the person or persons for whom the services are performed indicates a degree of control.

FURNISHING OF TOOLS AND MATERIALS

The fact that the person or persons for whom the services are performed furnish significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship.

WORKING FOR MORE THAN ONE FIRM AT A TIME

If a worker performs services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor.

RIGHT TO TERMINATE

If the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer- employee relationship.

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?

Yes, they can! However, you should make sure that they are not working for your direct competition. If they are, then you may have a problem. You should make sure that your contractors are aware of any non-compete clauses in their contract. These clauses will prevent them from working for your competitors for a certain period of time.

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 you?

Usually practices will start off with 1099 Contractors because they don’t understand taxes and there are less steps in payroll. Generally speaking, you will likely pay more taxes and benefits for employees than for contractors.

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. 

Oftentimes, employees are more focused and devoted to your business’ mission and goals.

If you are unsure or would like further help, consult with an accountant or attorney to determine which option is best for you.

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

Many practices will start with 1099 contractors in the beginning because they aren’t sure how to lead their practice. When they start to build a culture and figure out how to run their practice well, often they will switch to employees. This is not always a smooth transition.

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

So, there you have it! As you can see, there is no one size fits all answer when it comes to choosing between hiring W-2 employees or independent contractors.

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.