If you’re an employer hiring workers, you’ll have to make a decision about whether you bring someone on as an employee on payroll or as an independent contractor. This decision will have an impact on how that worker is paid and how taxes are withheld from their paycheck. You’ll need to inform the IRS of your decision by turning in Form W-2 for employees on payroll and Form 1099-NEC for independent contractors.
Getting this decision right is important, with ramifications for your employees and your business, so understanding the difference between 1099 vs W-2 employees is key.
Key Points
• Whether or not an employee received a Form W-2 or a Form 1099-NEC will depend on their role at a company.
• W-2 workers tend to be formally employed with a company, and employers have greater control over how work is done.
• A 1099 employee is an independent contractor. Employers cannot control how these workers complete work, only the end product.
• Employers must withhold income taxes from W-2 employees’ paychecks and pay full employment taxes.
• A 1099 contractor is responsible for paying their own taxes.
Employee Classification Basics
Depending on a worker’s role at a company, employers must supply the IRS with one of two types of tax forms. It can be, either a Form 1099-NEC or a Form W-2. Freelancers, or independent contractors, are typically asked to fill out a 1099. Employees on payroll will be asked to fill out a W-2.
W2 Employee Characteristics
A W-2 worker is someone who is formally employed with a company or an organization. They may work full-time or part-time and may be salaried or hourly employees.
Employers typically have a lot of control over how W-2 employees work, including over the tools and processes needed to reach a desired outcome. In return, W-2 employees are often entitled to a lot of protections, such as minimum wage, overtime, and family or medical leave. W-2 employees often participate in employer benefit programs, such as health insurance and retirement plans.
1099 Contractor Definitions
In general, independent contractors are self-employed. They are workers in an independent trade, business, or profession who supply services to the general public. For instance, this category could include professionals such as doctors, lawyers and accountants, or subcontractors who are providing skilled labor to an organization, such as software engineers or graphic designers..
Legally, employers cannot control the details of how services are performed by independent contractors, such as how work is to be performed and when. They can only control the result of the work. Independent contractors typically do not participate in employer benefit packages.
Tax Implications
The tax treatment of W-2 versus 1099 employees is one of the most marked differences between these types of workers. Employers carry much of the burden of withholding and paying taxes for W-2 employees, while 1099 employees shoulder all of the responsibility themselves.
A 1099 employee may be able to make more tax deductions against the equipment, supplies, and other expenses related to their business.
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Employer Responsibilities
W2 employees have taxes withheld from their paycheck by their employer, including income taxes, Social Security taxes, and Medicare taxes. Employers must pay the matching employer portion of Social Security and Medicare taxes, as well as unemployment taxes.
For 1099 employees, on the other hand, employers don’t have to withhold or pay any taxes on payments.
Employee/Contractor Obligations
For all intents and purposes, 1099 workers are their own employers. That means they are responsible for covering all taxes on their own, including self-employment tax. The current self-employment tax rate is 15.3%, which includes 12.4% for Social Security and 2.9% for Medicare. This self-employment tax is double what W-2 employees pay, as their employers cover half of this amount for them.
Deduction Differences
Taxes on wages for W-2 employees are withheld directly from their paychecks along with other payroll deductions. The employee never receives that money unless they get some back in the form of a tax return. When it comes to income tax, the employer will decide how much to withhold based on the employee’s Form W-4, Employee’s Withholding Certificate.
Ideally, the amount withheld over the course of a year would equal exactly the amount owed on an employee’s annual federal income taxes. If the employee’s withheld amount is more or less than this, they may want to adjust their withholding accordingly.
Because taxes are not withheld from 1099 employees’ paychecks, these workers may owe quarterly taxes instead. These are estimated payments to the IRS four times per year. Depending on an independent contractor’s income in a given quarter, these payments may vary. However, ideally, these too will add up to equal the amount owed on an employee’s annual income tax return.
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Making the Right Choice
It is an employer’s responsibility to make the right choice between offering a W-2 and a 1099 to the workers they hire. It’s important to get this decision right. Failure to do so can result in legal or financial ramifications. For example, if workers are incorrectly identified as independent contractors, employers might be liable for back employment taxes.
In general, if an employer controls what a worker does and how, they are likely a W-2 employee. Similarly, if the employer controls aspects of their job such as how they’re paid and whether they’re reimbursed for expenses, they are likely a W-2 employee. The same is true if they are offered company benefits.
If none of these apply, the hired contractor is likely a 1099 contractor.
Be aware that a worker’s relationship to a business can change over time, so it’s important to reassess it periodically to determine if their W-2 or 1099 status has changed.
Employee Status Tests
There are several tests from the IRS, Department of Labor (DOL), and the Equal Employment Opportunity Commission (EEOC) that employers can apply to workers to help determine whether they are 1099 contractors or W-2 employees.
• IRS common law rules look at behavioral control, financial control, and the type of work relationship.
• The DOL uses an economic reality test, to determine if a worker is a W-2 employee and covered by the Fair Labor Standards Act. This law entitles workers to minimum wage, overtime, and other protections.
• The EEOC offers a set of criteria for W-2 employees as well, such as whether work is performed on the employer’s premises or the employer provides tools and materials to complete the work.
The Takeaway
The differences between W-2 employees and 1099 contractors is largely based on the relationship that worker has to your business and the work they do for you. The classification you choose will have a big impact on your business and how your workers are paid. For this reason, it’s important to consider it carefully and to avoid potential financial and legal penalties.
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FAQ
Do 1099 employees pay more taxes than W-2 employees?
1099 employees are responsible to pay the full federal employment tax amount of 12.4% for Social Security and 2.9% for Medicare. W-2 employees only pay half that amount.
Can a worker be both 1099 and W-2?
There are a couple scenarios in which you may have a W-2 and a 1099. It is common for workers to work for multiple employers. One may hire a worker as an independent contractor with a 1099, while another may hire a worker as an employee with a W-2. It’s possible to receive both from the same employer if a worker performs two completely different duties for the company with one qualifying as a W-2 employee and another as independent work.
What benefits do W-2 employees receive?
W-2 employees pay less in employment taxes and may receive greater access to employer benefit plans, such as retirement accounts.
Is it better to be a 1099 contractor or W2 employee?
Both 1099 contractors and W-2 employees receive benefits that may be advantageous. For example, 1099 contractors may be able to write off more expenses on their taxes, while W-2 employees pay less in employment taxes.
Can a company switch me from W-2 to 1099?
If your role changes at your company, your employer may switch you from a W-2 employee to a 1099 contractor.
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