When hiring employees, there are two types of tax forms you will be dealing with, 1099s and W-2s. A 1099 form used to report payments when you hire an independent contractor and a W-2 form is used for employees whose payroll taxes are withheld from their earnings. Let’s dive into the difference between the two.
1099 vs. W-2 Workers
The difference between 1099 and W-2 workers matters when it comes to taxes and the standards set by the IRS. Employees (W-2 workers) tend to benefit from perks, such as benefits packages, paid leave and a fixed income. While independent contractors (1099 workers) usually need to pay for their own health coverage and retirement planning.
What is a W-2?
The W-2 tax form, also referred to as the Wage and Tax Statement, is sent to every employee who works for your business at the beginning of the year. A W-2 informs your employees about their withholding over the course of the year and itemizes all their deductions for tax purposes. An employee uses the information to determine if they’re entitled to a tax refund for overpayment or if they still owe the IRS money.
What to Know About W-2s
A W-2, often confused with a W-4 (the document employees need to complete when they’re first hired or when they want to change their withholding amounts) is required If you’ve paid an employee more than $600 over the past year. You are required to complete and send this document to all employees by January 31st.
The point of a W-2 is to report important information to the employee, federal government and the state revenue service including:
- Total income subject to taxation: This is the employee’s wages for the year after pretax deductions. This is 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.
As an employer, you should send as many copies of W-2 forms as needed to file taxes with the federal government as well as state and local governments. This can be done in hard copy and made available in digital form. An additional copy should be kept for your own records, with a copy of the W-2 filed with the IRS and a W-3 to remain compliant with federal income tax law.
Required Information for W-2s
There are three pieces of information you need to provide a W-2, which should have already been provided when the employee filled out their W-4:
- 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.
What is a 1099?
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.
Independent Contractor Misclassification
To help prevent financial penalties and lawsuits, you need to make sure you are classifying workers correctly. Employee misclassification happens when workers are mislabeled as independent contractors rather than employees.
The IRS looks at three categories to determine whether you hired an employee vs. an independent contractor:
- Behavioral: Do you control what the worker does or how they do their job?
- Financial: Do you control how the worker is paid or whether expenses are reimbursed?
- Type of relationship: Did you hire the employee using a written contract or are you offering employee-type benefits (i.e., insurance, vacation, 401(k), etc.)? Is the relationship permanent or short-term?
What to Know About 1099s
There are numerous types of 1099s that report income for different purposes, but 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 over $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 more than $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
Types of 1099 Forms
There are numerous types of 1099 forms, but the most common forms are the 1099-NEC and the 1099-MISC. Form 1099-NEC is used to report income for independent contractors and form 1099-MISC is used for miscellaneous compensation.
Tax Withholding for 1099 Workers
Along with sending a copy of the 1099 to your contractor or freelancer, the IRS requires businesses to submit a copy of an independent contractor’s 1099 to the IRS, Social Security Administration and state and local tax revenue services. Like with W-2s, these are due by January 31st each year.
The upside of hiring independent contractors is that businesses aren’t required to withhold taxes. However, should a contractor request that a business withhold tax payments, the form includes boxes to indicate tax withholding. 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.
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. isolved offers payroll and tax solutions to help your business avoid any penalties or legal issues.