Paying W2 Employees vs 1099 Contractors in the US

In the evolving landscape of employment, the distinction between paying W2 employees and 1099 contractors is significant, especially when navigating the intricacies of hybrid fiat and crypto payroll systems. This guide aims to elucidate these differences, focusing on the operational and compliance aspects crucial for businesses. 

As we embark on this exploration, we highlight how digital currency intersects with traditional employment frameworks, offering insights for employers to manage their workforce effectively.

Understanding the Basics: W2 Employees vs. 1099 Contractors

At the heart of the US employment system lie two primary categories: W2 employees and 1099 contractors. W2 employees are the backbone of the traditional workforce, receiving salaries or wages, benefits, and legal protections. In contrast, 1099 contractors operate independently, offering services on a project basis without the perks of employment but with greater freedom and responsibility for their tax obligations. 

Through partnerships, platforms like Rise extend benefits to freelancers, enhancing the appeal of the 1099 contractor model.

W2 and 1099 are terms specifically related to the United States tax and employment systems. They refer to the forms used by the Internal Revenue Service (IRS) to report different types of income.

• W2 Form: This is used to report wages, salaries, and other compensation paid to an employee, along with the taxes withheld from their paycheck by their employer. Employers must issue a W2 form to each of their employees to whom they pay a salary, wage, or other compensation. W2 employees are considered to be on the payroll, and their employers are responsible for withholding income taxes, Social Security, and Medicare contributions.
• 1099 Forms: These are used to report various types of income other than wages, salaries, and tips (for which a W2 form is used). The most common type of 1099 form is the 1099-NEC, which is used to report income paid to independent contractors (previously reported on the 1099-MISC). Independent contractors are considered self-employed and are responsible for paying their own taxes, including self-employment tax. The 1099 forms reflect the fact that the payer has not withheld any federal or state income taxes or Social Security/Medicare contributions.

In other countries, similar concepts exist but are referred to by different names and involve different forms or procedures. Each country has its own tax laws and employment classifications that determine how workers are categorized and how their income is reported for tax purposes.

Major Differences in Payments and Compliance

The financial and administrative burden of hiring W2 employees surpasses that of engaging 1099 contractors. Employers must cover benefits, training, and workers' compensation for W2 employees and adhere to stringent tax withholding and reporting requirements. 

Conversely, 1099 contractors present a cost-effective solution with lower regulatory overhead, though this comes at the cost of less direct control over work outcomes. Ordinarily, hiring 1099 contractors is cheaper for the business as again, perks such as insurance don’t have to be paid for. You also don’t have to pay for their training, downtime or workers compensation. 

1099 contractors also don’t require any tax withholding at the payroll level, whereas W2’s need to have their medicare, social security and income taxes withheld and remitted.

Related: Best Payroll for Small Business

W2’s are also protected by most of the employment laws such as the fair labour standards Act, making each of them a much higher regulatory burden on the business as opposed to 1099s.

1099s often come with additional flexibility over when and how they can work for you but this makes it harder to control their outputs as much. This flexibility demands a payroll system that is not anchored to only rigid payment schedules, an element that we at Rise excel at.

Now that we have a grasp of who we're dealing with, let's explore what happens when these individuals get paid in both cryptocurrencies and traditional fiat currencies. The legal implications vary depending on the country. While some nations consider cryptocurrencies as legal tender, others categorise them as property or assets. As a result, paying W2 employees or 1099 contractors in crypto may have different tax and compliance requirements.

Operational Differences: AOR vs EOR vs PEO

There are 3 major terms we must familiarise ourselves with to begin with along with their associated legal, tax and administrative responsibilities.

Understanding the roles of Agents of Record (AOR), Employers of Record (EOR), and Professional Employer Organizations (PEO) is crucial for navigating the employment landscape:

• AOR services are tailored for managing 1099 contractors, streamlining payment processes and ensuring tax compliance without delving into the benefits provision.
• EOR entities assume comprehensive legal employer responsibilities, facilitating international employment without the need for local corporate presence, and offering a full suite of employee benefits.
• PEO partnerships allow for shared employment responsibilities, requiring an existing legal entity but offering co-managed HR functions and benefits.

Agents of record (such as Rise) act as an intermediary between a business and its 1099 contractors. It is usually responsible for managing contractor payments, ensuring compliance with tax laws and handling contractual documentation. This means that the contractors themselves receive 1099 tax forms and are responsible for paying their own taxes, which include self-employment tax.

PEO stands for Professional Employer Organization and is classified as an ‘employment partner’ that manages HR tasks such as payroll, benefits, tax deductions and reporting. To utilise them however, it is necessary that your business already has an established legal entity within all countries that it hires from. This makes it the more affordable option where these legal entities are available. Using a PEO also means that the business joins a co-employment arrangement between the company, the employee and the PEO itself. This results in the company being solely responsible for compliance with local labour laws.

EOR stands for Employer of Record and shares the same status of ‘employment partner’ as PEO but with that comes a few major differences. An EOR can employ workers in other countries on your behalf without your company needing to open its own entity in each. It acts as the legal employer of your workers on paper. This means that non-US companies wanting to hire US-based W2 employees would be much better aided by EOR’s due to their compatible services/demands.

The differences between hiring and paying contractors as 1099 contractors via an Agent of Record (AOR) and employing individuals as W2 employees through an Employer of Record (EOR) or a Professional Employer Organization (PEO) are primarily related to the legal, tax, and administrative responsibilities associated with each method. Each of these approaches has its own set of implications for how workers are managed, taxed, and provided with benefits.

1. 1099 Contractors via an Agent of Record (AOR)

• Definition: An Agent of Record acts as an intermediary between a business and its 1099 contractors. The AOR is responsible for managing contractor payments, ensuring compliance with tax laws, and handling contractual documentation. Contractors are not considered employees of the business; they are independent.
• Tax Implications: Contractors receive 1099 forms for tax purposes and are responsible for paying their own taxes, including self-employment tax. The hiring company does not withhold taxes.
• Benefits and Protections: Contractors typically do not receive benefits like health insurance, retirement plans, or workers' compensation from the hiring company. They also lack certain legal protections and employment rights that are available to W2 employees.
• Control and Flexibility: Businesses have less control over how contractors complete their work, providing only project specifications. Contractors have more flexibility regarding their work hours and methods.

2. W2 Employees through an Employer of Record (EOR)

• Definition: An Employer of Record is an organization that takes on the legal responsibilities of employing staff on behalf of another company. The EOR handles payroll, taxes, benefits, and compliance with labor laws for W2 employees.
• Tax Implications: The EOR withholds income taxes, Social Security, and Medicare taxes from employees' wages. The EOR also contributes to unemployment and workers' compensation insurance.
• Benefits and Protections: Employees under an EOR arrangement receive benefits provided by the EOR, including health insurance and retirement savings plans. They also enjoy protections under labor laws, such as minimum wage and overtime pay.
• Control and Management: The client company retains control over the day-to-day management and direction of the employees' work, while the EOR manages employment-related administrative tasks.

3. Professional Employer Organization (PEO)

• Definition: A PEO enters into a co-employment arrangement with a company, sharing responsibilities for employees. The PEO handles HR functions, payroll, benefits administration, and compliance with employment laws for W2 employees.
• Tax Implications: Similar to an EOR, a PEO withholds and pays taxes on behalf of the employees. The difference lies in the co-employment relationship, with both the PEO and the client company sharing employer responsibilities.
• Benefits and Protections: Employees gain access to a broader range of benefits through the PEO, often at a lower cost due to the PEO's purchasing power. They also receive legal employment protections.
• Control and Management: The client company manages the employees' daily work and operations, while the PEO focuses on employment-related tasks. This model allows companies to offer competitive benefits and focus on their core business functions.

Comparing EOR vs PEO for W2 Employees

EOR services offer unparalleled flexibility for global hiring, reducing the legal and administrative hurdles associated with international employment. This model is ideal for companies venturing into new markets without establishing local entities, providing a streamlined approach to global workforce management.

PEO arrangements, while beneficial for domestic employment, require a pre-existing corporate structure in the hiring country, making them less suited for international expansion but valuable for co-managed employment responsibilities within established markets.

While PEOs require a co-employment arrangement, where both the PEO and the client company share employer responsibilities, EORs take on the role of the sole legal employer. This means businesses can focus entirely on their core operations without needing to be involved in employment logistics, which is particularly beneficial for small to medium-sized operations like those commonly found within the crypto space.

For companies without the capability or desire to manage payroll, benefits, and HR functions, especially in multiple jurisdictions, EORs offer a way to outsource these tasks completely. This can lead to significant savings in terms of time and resources that can be better allocated to other branches of the business.

Coming very soon, Rise will have full Employer of Record status meaning we can help be your gateway to adding top talent from the US to your workforce.

Crypto Taxation: Navigating the Legal Maze

Integrating cryptocurrencies into payroll introduces complexities, particularly in tax reporting and compliance. For W2 employees, traditional tax obligations extend to crypto payments, necessitating precise record-keeping and reporting. Paying 1099 contractors in crypto demands an understanding of the IRS's treatment of digital currencies as property, affecting the valuation and reporting of payments.

When dealing with W2 employees, businesses must tackle tax obligations akin to traditional fiat currency payrolls. Withholding taxes, such as income tax and Social Security contributions, need to be accurately calculated and reported. Just because you're paying in crypto doesn't mean Uncle Sam doesn't deserve his piece of the pie. Reporting requirements, like providing W2 forms at year-end, also remain unchanged. However, businesses need to adapt their reporting systems to include information related to crypto payments. It's all about staying compliant while staying ahead of the curve.

Paying 1099 contractors in cryptocurrencies introduces a whole new set of tax obligations. Businesses must report these payments on Form 1099-MISC, similar to traditional payment methods. However, the IRS views cryptocurrencies as property, which means businesses generally need to report contractor payments made in crypto as the fair market value of the digital coins on the day of payment. This requires accurate record-keeping and a good understanding of the value of the crypto at the time of payment. Keep those wallets and calculators handy.

At Rise, we help you minimise the total tax burden due to the way we streamline crypto to fiat routing. Converting USDC to USD does not constitute a taxable event as the value of the cryptocurrency (stablecoin) is equal to that of the fiat currency at any given time of exchange. This combined with the fact that payments made to workers are done in USD means a far simpler result in terms of tax reporting.

The Rise Advantage

As the landscape of employment continues to evolve with the integration of cryptocurrency, platforms like Rise are at the forefront, offering innovative solutions for both W2 employees and 1099 contractors. With the advent of our Employer of Record status, we are expanding our capabilities to facilitate the hiring of top talent from the US and beyond, ensuring compliance, efficiency, and security in payroll processes.

Employing W2 workers or contracting 1099 freelancers presents distinct challenges and opportunities, particularly when integrating crypto payments. Businesses must carefully consider their operational needs, compliance obligations, and the strategic benefits of each employment model. With the right partners and platforms, companies can navigate these complexities, leveraging the advantages of both traditional and digital payroll systems to foster a flexible, inclusive, and efficient workforce.

By embracing the potential of EOR services like Rise for international hiring and leveraging the flexibility of AOR for managing independent contractors, businesses can harness the power of global talent while ensuring compliance and operational efficiency in the dynamic world of work.