The difference: 1099 vs W-2

When businesses hire people, they hire employees to perform tasks that are directly managed by supervisors and independent contractors who receive performance-based pay. A good example of this is the difference between a sales representative and a warehouse worker.

The sales representative only gets paid when they sell products, and the amount ofcompensation they receive varies from one pay period to the next. The warehouse worker might receive an hourly rate or a salary that remains the same, regardless of how well they perform their duties. Sales representatives are independent contractors, while warehouse workers are employees.

Independent contractors are responsible for their own tax planning, and businesses aren’t required to withhold taxes, FICA or Medicare tax from their paychecks. Employees are subject to regular tax withholding, so the amount of money withheld from their pay over the course of the year reduces the amount of money they’ll owe the IRS when it’s time to file taxes.

A 1099 reports an independent contractor’s pay to the IRS while giving that worker a record of their wages, so they can file and pay their taxes. W-2s inform employees about their withholding over the course of the year and itemize all their deductions for the year for tax purposes. An employee can then use the information provided to determine if they’re entitled to a tax refund for overpayment or if they still owe the IRS money.

What you need to know about W-2s

The W-2 form is referred to as a Wage and Tax Statement and 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, whichisthe document employees need to complete when they’re first hired or when they want to change their withholding amounts. If you’ve paid an employee more than $600 over the past year, you’re required to complete and send this document to them by January 31st.

The W-2 reports several things to the employee, federal government and the state revenue service:

• Total income subject to taxation: This is an employee’s wages for the year after pretax deductions. It’s what the IRS uses to determine the employee’s tax bracket and total taxes owed on their income.
• FICA and Medicare withholding: Social Security and Medicare aren’t technically taxes since they are payments into services employees receive later in life. They’re withheld separately from federal and state taxes based on each employee’s taxable income.
• Federal tax withholding: This is the amount of money a business withholds from an employee’s pay for the purpose of paying their federal taxes.
• State tax withholding: If an employer has employees who reside in a state that charges an income tax, state taxes are withheld in a similar fashion to federal tax withholding.
• Local tax withholding: In rare cases, employees may reside in a city that enforces a local income tax. If this is the case, taxes might be withheld from an employee’s check for local taxes.

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 remain compliant with federal income tax law.

Required information to provide W-2s to employees

Most of the information needed to provide a W-2 has already been recorded when an employee filled out 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 needs to be updated.
• Employee address: In cases where an employee has had a change of residence, you need to confirm where to send the W-2.
• 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 vs 1099 is that it includes withholding information. Since you’ve withheld taxes throughout the year and paid them to the IRS on behalf of your employees, they need to know the total amounts, so they can file their returns in a timely fashion.

What you need to know about 1099s

The 1099 may be confusing because there are numerous types of 1099s that report income for different purposes. What all 1099s have in common is that they’re statements of income made for the year from your company. Businesses are required to report all sources of income that individuals receive if they’re paid more than $600 for the year.

1099s can be used 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

There are numerous types of 1099 forms, but the most commonly used 1099s are the 1099-NEC and the 1099-MISC. The 1099-NEC is used to report income for independent contractors and other nonemployee compensation, while the 1099-MISC is used for miscellaneous forms of compensation. Most independent contractors and freelancers would receive a 1099-NEC.

The IRS requires that you submit a copy of an independent contractor’s 1099 to the IRS, Social Security Administration and state and local tax revenue services. It’s also important to send copies to the contractor or freelancer. These documents are due by January 31st each year.

You need to ensure that all the information needed to send the document is accurate by verifying it with the worker prior to the end of the year. The same information needed to send a W-2 is also needed for a 1099. Should 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. The forms include boxes to indicate tax withholding in the event an employer withholds tax payments at the contractor’s request. In most instances, the number in this box will be $0.00 because it’s extremely rare for an employer to withhold tax for contracted work.

1099 vs W-2 workers

It’s important that businesses consider their workers as employees or independent contractors based on the standards set by the IRS. Employees tend to benefit from perks, such as benefitspackages, paid leave and a fixed income. While some independent contractors are offeredbenefitsin the form of insurance or retirement accounts and otherbenefits, most need to pay for their ownhealth coverageand retirement planning.

The IRS defines an employee as anyone who performs a service where the employer controls both what is done and how the duties are performed. An independent contractor isn’t bound to any employer and is free to work for as many businesses as they desire. While you can control the expected result, you’re unable to control what the worker does to deliver the service or product.

Sales representatives are independent contractors because they contact leads,make cold calls and are responsible for all communications between the customer and business up to the point of the close. Freelancers are also independent contractors because they provide a service for a limited period of time until delivering the desired product or service. Doctors, lawyers and accountants are examples of workers who might be considered independent contractors.

Since some of these 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?

Behavioral control is defined by the degree to which a business structurestasks. If the employer controls the work environment, owns the equipment the worker uses, provides training, controls the worker’s hours, gives the worker 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 is 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 be considered employees.

Another form of financial control is the method of payment. Employees are given a set rate of pay based on the time they commit to their duties. This can be an hourly wage or a salary that remains steady, 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 only gets paid when making a sale would be considered an independent contractor. This is because they receive a flat fee for each sale and 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 whenever it suits them. Employees work the hours their employer determines and have a long-standing relationship with their employers. If there is a specified time period that the worker stays with the company or the worker is only hired until the completion of a specific task, that person would be considered an independent contractor.

Additional resources

If you’re having trouble determining whether your new hire should receive a 1099 vs W-2, the IRS provides two resources that can help. The first isForm SS-8 Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. You can also refer toPublication 15-A, which is the IRS’s Employer’s Supplemental Tax Guide.

Now that you know the key difference between W-2 and 1099 tax reporting, you can properly classify your workers. There are penalties and legal challenges that can be brought against businesses that don’t classify workers correctly and meet income reporting requirements. To avoid these downfalls, it’s important to meet with a tax specialist to ensure that you’re managing your work staff correctly in regard to tax reporting and withholding.