W-2 vs 1099: What is the difference?

Businesses hire employees to perform tasks that are directly managed by supervisors or independent contractors who receive performance-based pay.

For example, a warehouse worker who follows set schedules, uses company equipment and reports to a supervisor is typically classified as an employee. In contrast, a contractor hired to complete a defined project and paid on a per-deliverable basis may qualify as an independent contractor, depending on the Internal Revenue Service (IRS) criteria.

Independent contractors are responsible for their own tax planning, and employers are not obligated to withhold Federal Insurance Contributions Act (FICA) and Medicare taxes from their wages. Employees are subject to regular tax withholding, and the amount of money withheld from their pay over the course of the year reduces the amount they will owe the IRS when it is time to file taxes.

A 1099 reports an independent contractor’s pay to the IRS and provides a record of their earnings for tax filing. W-2s show an employee’s wages and the amount of taxes withheld during the year; they do not list all tax deductions the employee may claim on their return. Employees can use the information to determine whether they’re entitled to a tax refund for an overpayment or if they owe the IRS money.

“Classifying your workers correctly isn’t just a paperwork issue. It can affect payroll taxes, benefits, compliance risk and even company culture. I always encourage employers to slow down and evaluate the IRS control tests before deciding whether someone should receive a W-2 or a 1099. A thoughtful decision made early on can help prevent costly corrections later.”

—Ashlee Malet, MBA in accounting

What employers need to know about W-2s

The W-2 form, also known as a Wage and Tax Statement, must be sent to every employee who works for your business at the beginning of the year. It’s often confused with the W-4 form, which employees are required to complete when they’re hired or when they want to change their withholding amounts.

If your business pays wages that are subject to federal income tax withholding (and other W-2 reporting requirements), you generally must provide the employee with a W-2 by January 31.

The W-2 reports the following to the employee, the federal government and state revenue services:

• Total income subject to taxation: This is an employee’s wages for the year after pretax deductions. The IRS uses this amount to determine the employee’s tax bracket and total taxes owed based on their income.
• FICA and Medicare withholding:Social Security and Medicare are federal payroll taxes (FICA) that are withheld from employees’ pay along with other required withholding, and they are calculated based on applicable wage bases and rates.
• Federal income tax withheld: This is the amount of money a business withholds from an employee’s salary to pay their federal taxes.
• State income tax withheld: If an employer has employees who reside in a state that imposes an income tax, state income tax is withheld in the same way as federal tax withholding.
• Local tax withholding: If an employee resides in a city that enforces a local income tax, those taxes may be withheld from their paycheck.

Employers send employees as many copies of their W-2 forms as they need to file taxes with the federal government and their state and local governments. They also receive an additional copy for their own records. Copy A of the W-2 must be filed with the IRS with a W-3 to comply with federal income tax law.

Information required to issue W-2s

Most of the information required to complete a W-2 is recorded when an employee completes their W-4. Since circumstances can change, it’s important to verify that the following information is still accurate:

• Employee name: If an employee has recently married or filed for a change of legal name, this must be updated.
• Employee address: If an employee has changed residences, confirm where to send the W-2.
• Employee’s Social Security number: It’s important to confirm that the Social Security number you have on record is correct.

The primary difference between a W-2 and a 1099 is that a W-2 includes withholding information. Employees need to know the amount of tax a business withheld and submitted to the IRS on their behalf, so that they can file their annual tax returns.

What employers need to know about 1099s

Several types of 1099s report income for different purposes. However, all 1099s are statements of income issued by the company for the year. Businesses are generally required to report certain payments of $600 or more made during the year, such as non-employee compensation, rent and specific service payments, depending on IRS reporting rules.

You can use 1099s to report the following:

• Money paid for contracted services
• Sales commissions
• Payments made to freelancers
• Attorney fees in excess of $600
• Rent or lease payments
• Payments made to accountants who are not considered employees
• Pension payments
• Other forms of compensation that can be considered income

The most common 1099s are the 1099-NEC and the 1099-MISC. The 1099-NEC is used to report income from independent contractors and other non-employee compensation. The 1099-MISC is used for miscellaneous forms of compensation. Most independent contractors and freelancers receive a 1099-NEC.

Employers file 1099-NEC forms directly with the IRS and may also need to comply with applicable state filing requirements. To meet IRS deadlines, employers must provide contractors or freelancers with their copies of the 1099 by January 31.

Confirm details with the worker before the end of the year to ensure all 1099 information is accurate. This documentation mirrors the details recorded in W-2s. If you hire an independent contractor who does business as a C corporation or S corporation, you’re exempt from the requirement to send a 1099.

Tax withholding for 1099 workers

Businesses aren’t required to withhold taxes for independent contractors, freelancers and other workers who receive 1099s. In most cases, the number in this box will be $0.00 because it’s rare for an employer to withhold tax for contracted work.

W-2 vs 1099 workers

IRS standards establish whether employers consider workers as employees or independent contractors. An employee is defined as anyone who performs a service where the employer controls both what is done and how the duties are performed. Employees often receive perks, such as benefits packages, paid leave and a fixed income.

An independent contractor isn’t bound to any employer and may work for multiple businesses. While employers can control the expected result, they cannot control how the worker delivers the service or product. While some independent contractors have access to group benefits like insurance or retirement accounts, most must manage their own benefits and retirement planning.

The following are examples of independent contractors:

• Sales representatives: They contact leads, make cold calls and are responsible for all communications between the customer and business up to the point of the sale.
• Freelancers: They provide a service for a limited period, until they deliver the desired product or service.
• Doctors, lawyers and accountants: These workers might be considered independent contractors.

How to classify workers

Since some roles can still be considered employees under the correct circumstances, the following questions can help you determine how to classify your workers:

Does my business control the worker’s behavior?

The degree to which a business structures tasks defines behavioral control. If the employer controls the work environment, owns the equipment the worker uses, provides training, controls the worker’s hours, assigns specific tasks and controls the supplies and services used to perform duties, the worker is an employee.

Is regular training provided?

Most workers receive some form of training when joining a new company. The depth and regularity of the training determine whether someone is an independent contractor or an employee. Employers control how often employees receive training and how the training is conducted.

Does my business have financial control over the worker?

If the employer maintains financial control over how duties are performed, the worker may be considered an employee. For example, independent contractors invest money in their own equipment, pay their own expenses and don’t have a significant investment in your business. However, workers who receive reimbursement for the cost of their tools, transportation costs and other job-related expenses would typically be considered employees.

Another form of financial control is the method of payment. Employees are paid a set rate based on the time they commit to their duties. This can be an hourly wage or a steady salary, regardless of job performance. Sales representatives who receive base pay in addition to commissions are considered employees due to the expectation of a defined salary.

Independent contractors receive a fee for each service they provide. For example, a sales representative who is paid only when completing a sale is considered an independent contractor because they receive a flat fee for each sale and have no guaranteed weekly wage.

Does the employee have a permanent relationship with my business?

Independent contractors are free to terminate their relationship with a company at any time. Employees work the hours employers determine and have a long-standing relationship with their employers. If a worker is hired for a specified period or to complete a specific task, that person would be considered an independent contractor.

Additional resources

If you’re unsure whether your new hire should receive a W-2 or a 1099, the IRS provides the following two helpful resources:

• Form SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding
• Publication 15-A, which is the IRS’s Employer’s Supplemental Tax Guide

Understanding the difference between W-2 and 1099 tax reporting helps you classify your workers correctly. Accurately classifying your workers helps your business remain compliant and avoid penalties or legal challenges regarding income reporting requirements. Consider meeting with a tax specialist to verify you’re managing your staff correctly for tax reporting and withholding.

This article is for informational purposes only and does not constitute financial advice. Consult with a licensed financial professional for any issues you may be experiencing.