What is W-2 vs. 1099 Employees?

When you run a business, how you classify your workers matters a lot. It affects your taxes, legal responsibilities, and even how you manage your team.

W-2 Employees: These are your traditional employees. You, as the employer, withhold income tax, Social Security, and Medicare taxes from their paychecks. You also pay a portion of these taxes. W-2 employees typically work set hours, use your equipment, and follow your direct instructions. They are eligible for benefits like health insurance, paid time off, and retirement plans.

1099 Contractors: These are independent contractors or freelancers. You pay them for their services, but you do not withhold taxes. They are responsible for paying their own self-employment taxes (Social Security and Medicare) and income taxes. 1099 contractors usually set their own hours, use their own tools, and work on specific projects or tasks without direct supervision. They are not eligible for employee benefits from your company.

The IRS has strict rules to determine if a worker is a W-2 employee or a 1099 contractor. Misclassifying workers can lead to significant penalties, back taxes, and legal issues. It is crucial to understand the difference and classify your workers correctly.

The classification of your workers directly impacts your business valuation. W-2 employees come with higher payroll taxes, benefits costs, and administrative burdens. 1099 contractors generally have lower direct costs and fewer administrative responsibilities.

From a buyer's perspective, a business with a high reliance on 1099 contractors might look more attractive due to lower fixed costs and greater flexibility. However, if those 1099 contractors are misclassified and should legally be W-2 employees, it presents a significant risk to the buyer. This risk can lead to a lower valuation or even scuttle a deal.