Comparing the Costs of W-2 Employees vs 1099 Contractors

For owners of small and growing companies, every dollar counts. This is especially true when it comes to hiring a team to build out your business. A very common misconception is that 1099 contractors are always cheaper than W-2 employees. This is a myth! 

Here, we'll compare the costs of hiring a W-2 employee vs a 1099 contractor, and dive into the factors business owners will want to consider when determining which is right for their company.

Which Costs Less?

I recently conducted a Linkedin survey to understand the perception between 1099 vs W-2 in terms of cost to a business. The results, though not statistically significant, shocked me a little. There was a large sway toward thinking contractors are cheaper, with this option getting 79% of the votes. And only 21% said W-2 employees cost less. 

To me, this highlights two major things. First, financial analysis is crucial for key decision-making, because the results are often counterintuitive. And second, more CEOs need to understand what cost-efficient teams look like for growing businesses. 

There are major advantages to using 1099 freelancers or experts such as Fractional CFOs, COOs, and CMOs. There can be cost savings in the early days of a business when owners are figuring out what skills they need on their teams, or needing less than part-time help. However, it might be surprising to know that W-2 employees are often cheaper in the long run and can be a much more efficient way to grow a small business. 

Related Article: Busting 4 Common Myths Around Employees and Independent Contractors

The Costs of W-2 vs 1099

Let’s go through an example to break down the apples-to-apples cost of a W-2 vs a 1099. To make things easy, we’ll break both into an hourly rate and exclude taxes and other costs for now (more on that in the next section).

For this example, imagine you have a salaried employee that requires a base salary of $100,000 and are comparing that to a 1099 contractor that needs to make the equivalent income. 

A W-2 employee that earns a $100,000 base salary and is receiving health insurance is costing the businesses around $115,000 per year (benefits range from 15-30% of income). That works out to around $60/hour worked for a full-time employee who would be eligible to receive health insurance, and might take typical amounts of sick time, vacation, and paid holidays. 

A 1099 contractor who wants to make the same amount will need to have an hourly rate that includes $115,000 annual pay to cover salary and health insurance. They also need to account for their unpaid vacation, sick time, or holidays. Additionally, they also handle their own admin, HR, and IT, so they will need time to send invoices, network, fix their computer, etc. They may even use a third-party platform to find work, and those vendors typically draw a referral or placement fee. So, even if the contractor does the same work, they need to adjust their pay to cover all those expenses. They would likely need to bill at least $86/hour to get the same compensation as the W-2 employee. 

$86/hour is $16/hour higher than the same role for a W-2 employee. And depending on the market and level of seniority, you may not always find such a good deal. It's not uncommon to see freelance rates for that level closer to $125-150/hour. That said, most good freelancers don’t need much (if any) training, so they can hit the ground running — saving some upfront costs for you as the employer. 

Other Important Hiring Considerations

Of course, hourly rates are not the only costs to consider. Typically, business owners see payroll taxes as the biggest barrier to hiring a W-2 employee. However, as noted above, a 1099 will likely be charging a high rate to cover those taxes. 1099 freelancers are still subject to payroll tax. The difference is that they are filing those taxes instead of the business owner. The expense to the business still exists whether you see it on the Profit & Loss statement (P&L) or not — don’t let payroll taxes fool you into thinking a W-2 is more expensive.

Another factor business owners see when they look at W-2 vs 1099 is the large amount of effort it takes to hire a W-2 employee. There are compliance requirements, payroll taxes, administrative costs, and processes you need to have in place to manage employees. However, W-2 employees tend to have less frequent turnover than 1099s, so the investment often pays off.

Freelancers, on the other hand, typically love going from job to job and choosing their clients. They are often experts, and tapping into their skills can be a great way for employers to get a project going, have someone to fill in temporarily, or provide a very specialized level of support. But freelancers will very rarely be loyal to a company. Consistently replacing 1099 hires can cost you thousands of dollars each year that you could potentially have saved if you hired the right W-2 employee. 

Should You Hire a W-2 or 1099?

1099s and W-2s each have their pros and cons when it comes to making the right decision for your business. The cost differences are outlined above, as well as how many compliance issues can be handled via a partner like Justworks. Beyond that, here are some helpful considerations when you really want to make the best decision for your business. 

Here’s what you typically get when you hire a W-2 employee:

• Fully dedicated to your business (full time or part time)

• More oversight on their day-to-day work

Here’s what you typically get when you hire a 1099:

• Specialized support or comparatively high level of expertise 

• More flexibility if you only need someone a few hours per week or limited time

1099 contractors can be amazing when you are first starting your business, don’t know what you need, are trying out a new role, or need a highly specialized expert. As long as you're willing to accept the risks of contracting with a 1099 worker, it can offer a great solution. W-2 employees are best for long-term business growth, given the inherent risks associated with many 1099 arrangements. Plus, they can be less expensive, and the employment relationship provides more opportunities to develop loyalty and to optimize your business. 

When it comes to managing a team, a technology partner like Justworks takes the hassle and stress away from figuring out the tiny compliance details that feel like a lot of work for business owners. Justworks can also process payments to 1099 contractors so you can start building your W-2 staff while keeping some of your favorite freelancers. 

This blog post was written by a guest contributor. The views expressed in this article are the author's own, and do not necessarily reflect the views or opinions of Justworks.