Understanding W-2, 1099, and C2C Worker Classifications for Staffing Agencies

According to the American Staffing Association, 2.4 million temporary employees work for staffing agencies during the average week. 

It makes sense. Temp workers offer flexibility, fresh expertise, and speed, which can be invaluable for staffing agencies. Whether finding more employees for a busy period or hiring temporary talent to help get an in-house project over the line, temp workers are a great resource – all without the administrative fuss of onboarding an employee in-house.

However, one critically important area that businesses often overlook when hiring temporarily is worker classification.

Knowing whether you should classify an employee as a W-2, 1099, or Corp-to-Corp is essential when staffing in the US. Misclassification isn’t uncommon; it’s estimated that 30% of US employers have misclassified at least one worker. However, if you get it wrong, there could be severe penalties.

Even an honest mistake can lead to tax violation fines, fines for violating federal law, and damage a company's reputation.

Staffing agencies must know the difference and classify their temporary workers correctly.

Types of Worker Classification

Generally, temporary workers can be classified as W-2 employees, 1099 contractors, or Corp-to-Corp workers.

1. W-2 Employees

W-2 employees are defined as employees who receive wages from staffing agencies with their taxes withheld.

The "W-2" means that an employer must complete a W-2 tax form at the end of the year outlining all the employee’s compensation for the year and the withholdings made by the employer. The employee can then use this form to complete their income tax.

But there’s more to consider.

A W-2 employee is entitled to company benefits, such as health insurance, retirement plans, and paid sick leave.

Similarly, a W-2 employee will operate under the direct control of a staffing agency or client company.

An employer must also pay the employee’s employment taxes, such as Medicare and Social Security ("FICA"), state and federal unemployment insurance ("SUTA" and "FUTA"), and worker's compensation insurance. Collectively, these taxes and insurance are called "payroll burdens." An employer must also provide any legally required benefits and likewise comply with local, state, and federal labor laws, such as overtime pay.

Being classified as W-2 means a worker has greater employment stability and can rely on regular paychecks and reduced tax and benefit responsibility, as the employer is primarily responsible for managing these things.

2.  1099 Contractors

A 1099 contractor is an independent contractor, such as a freelancer. At its most basic, it’s any self-employed worker not belonging to a specific company. The contractor is not employed by the company, so they manage their taxes and benefits. "1099" is the name of the tax form that these independent contractors receive at the end of the year from the companies that pay them for their services.

Businesses usually hire 1099 contractors to help with specific projects that require skilled expertise that they do not have in-house. For example, a graphic designer could be hired to help with a one-off website project. As they aren’t employees, they can control their own work hours and methods.

In keeping with this, workers are responsible for managing their taxes, such as Medicare and Social Security, and maintaining control of their benefits, like health insurance and retirement savings.

Workers often opt for the 1099 route, as they can work on multiple projects simultaneously, potentially leading to higher earnings.

3. Corp-To-Corp (C2C) Contractors

Like 1099 contractors, workers who classify as C2C are independent contractors. However, the key distinction is they operate through their own business. When hired, they sign business-to-business contracts rather than individual service agreements. While technically, some "C2C" independent contractors will receive a 1099 tax form at the end of the year based on the type of entity they use, 1099 contractors are typically associated with individuals.

Often, workers who fall under the C2C classification are highly specialized and skilled in a niche field as they’ve developed themselves as an independent contractor over time.

As they operate their own business, workers must comply with corporate and personal tax laws and meet all legal and insurance requirements. Similarly, they are responsible for their expenses and manage their benefits.

As independent contractors, C2C workers control their working hours and business operations.

Key Differences Between Worker Classifications

W-2, 1099, and C2C classifications have distinct benefits and negatives for employers and employees.

1. Control and Flexbility

As previously mentioned, a W-2 classified employee is under the employer's control, whether this is the staffing agency itself or a client company. This means the employer can outline everything from work schedule tasks to how they complete them.

In comparison, 1099 and C2C classified contractors are in control of their work hours and methods. The only thing they’re responsible for is the deliverables which are expected to be produced.

2. Tax Implications

A staffing agency is entirely responsible for stating what is being withheld from a W-2 classified employee’s salary and maintaining their company benefits.

In comparison,1099 and C2C contractors are responsible for managing their tax payments.

3. Onboarding and other Compliance

When working with W-2 Employees, the staffing agency is responsible for the many state and federal onboarding requirements such as the I-9 Employment Authorization, harassment training, and other consents and disclosures required by law. The staffing agency must also ensure payroll compliance with wage and hour laws, and other HR laws that can vary dramatically between US states.

The onboarding and compliance requirements for 1099 and C2C contractors are much lower. Typically, they involve collecting a W-9 tax form and having the contractor sign an independent contractor agreement. Other than that, payment and other terms are spelled out in the contract, instead of the law, as it is for W-2 employees.

What are the Consequences of Getting it Wrong?

If a staffing agency misclassifies a worker, it can face severe consequences and even legal action. Just one misclassification can result in extra taxes, fines, and potential legal liabilities.

For example, if the IRS conducts an audit and discovers employees are misclassified, an employer could be liable for up to 100% of taxes owed plus penalties and a $50 fine for each unfilled W2 form.

If a staffing agency violates employment laws, such as federal overtime in the Fair Labor Standard Act ("FLSA") or state overtime rules, such as daily overtime in California, the penalties can be severe. Typically, the damages will be the pay owed plus a 100% fine for damages. Employees can seek class action lawsuits for missed wages and benefits. If your staffing agency has a large population of workers, your risk rises exponentially.

As a staffing agency, your ability to protect and comply with employment guidelines affects your reputation. If contractors or other temporary employees feel like you may misclassify them, then they’ll likely choose to work with another agency.

How Do I Avoid Getting it Wrong?

Unfortunately, correctly classifying your workers isn’t as simple as checking a box. The IRS and DOL criteria are based on numerous factors, including behavioral control, financial control, and the nature of the employee-worker relationship.

An employer must also consider state regulations. Each state has different criteria for classifying workers, such as W2, 1099, and C2C, so it’s essential to consider and double-check differences between states when hiring.

Ultimately, there is no secret to ensuring compliance; it requires a diligent approach that considers the guidelines placed on both a national and state level.

A Smoother Process?

Navigating IRS, DOL, and state guidelines is a time-consuming process. At worst, it can leave your staffing agency and client companies with severe legal and financial penalties.

If you’re looking for an easier way to handle employee classification, consider an Employer of Record (EOR) solution. An EOR solution can handle the administrative burden of hiring temporary employees by outsourcing all administrative work so you can be sure all your employees are classified correctly on both a federal and state level.

At Ascen, our back-office platform is designed to help staffing agencies classify their employees properly. As members of the American Staffing Association, we specialize in this area.

If you’d like to see how Ascen could help you maintain compliance and ease your administrative burden, please schedule a demo here.