1099 vs W2 for contractors: which one costs less

A W2 worker is your employee: you set the schedule, direct the work, and withhold and match payroll taxes on their wage. A 1099 worker is an independent contractor running their own business: they control their own hours and methods, usually supply their own tools, often work for other companies too, and invoice you rather than drawing a wage. The label on the paperwork does not decide which one applies; the actual working relationship does, judged against the IRS's behavioral-control, financial-control, and relationship factors (and your state's own test on top of that).

No. Classification follows the facts of the relationship, not a preference for lower payroll costs. If a worker is on your schedule, uses your tools and truck, works exclusively for you, and has done so for a long stretch, calling that person a 1099 subcontractor does not hold up in an IRS, DOL, or state unemployment audit, regardless of what any signed agreement says.

The IRS uses a three-factor common-law test: behavioral control (who directs how, when, and where the work happens), financial control (who bears the expenses and the opportunity for profit or loss, and whether the worker serves other clients), and the relationship of the parties (written contracts, benefits, permanency, and how central the role is to the business). No single factor decides it; the IRS weighs the whole relationship.

The employer typically owes the back employer-share of FICA taxes, unpaid unemployment insurance contributions, and interest for every affected pay period, and in cases of willful or repeated misclassification, additional penalties. Separately, if a court or the Department of Labor finds the worker was an employee under the Fair Labor Standards Act, unpaid overtime can come due, often with liquidated (double) damages. These are separate exposures that can both apply to the same worker.

Neither is reliably cheaper once you price it correctly. A W2 hire adds roughly 1.2 to 1.3 times the base wage in employer payroll tax, unemployment insurance, workers' comp, and any benefits, a widely used payroll-industry rule of thumb. A genuine 1099 sub skips that burden on paper, but a sub who prices their own self-employment tax, insurance, and downtime into their rate usually charges more per hour than a W2 wage for comparable skilled work. The real cost difference that matters is not the tax math; it is the cost of getting the classification wrong.

California (via AB 5, following the Dynamex decision), New Jersey, Massachusetts, and Illinois are the best known ABC-test states, and a handful of others apply a version of it for specific purposes like unemployment insurance. The ABC test presumes every worker is an employee unless the business proves all three prongs: free from the company's control, work that falls outside the company's usual business, and a worker independently established in their own trade.

Yes, and this is the part most 1099-vs-W2 explainers skip. The IRS test governs federal tax withholding. A separate Department of Labor economic-reality test under the Fair Labor Standards Act governs overtime and minimum wage. A separate state test usually governs unemployment insurance and workers' comp. A worker can pass one test and fail another, so passing an IRS-style checklist alone does not clear you on overtime or state unemployment exposure.

They should carry their own general liability and, in most states, their own workers' comp coverage, and you should have a current certificate of insurance on file for every sub before they start a job. If a sub has no insurance and gets hurt on your jobsite, your own general liability or workers' comp policy is often the one that ends up paying, and it also becomes evidence in a later audit that the relationship looked more like employment than an independent business.

There is no hard hour limit in the law, but exclusivity and duration are both factors the IRS, the DOL, and state agencies weigh. A sub who works 40 hours a week for a single company, year-round, with no other clients, looks a lot more like an employee than a genuine independent contractor, even though no rule says a specific number of hours automatically converts the relationship.

Duration alone does not decide it. A seasonal helper you direct day to day, using your equipment and your schedule, is usually a short-term W2 employee, not a 1099 sub, even if the engagement only lasts eight weeks. The behavioral and financial control factors apply the same way whether the relationship lasts three years or three months.