Compliance Corner Q&A

Stay compliant at tax time and avoid costly mistakes.

Every employer is required to issue their employees a tax form each year. Issuing the correct tax form is crucial in avoiding fines from the IRS. Misclassification of an employee can alter tax withholding, social security, Medicare taxes and impact both the employer and the employee’s tax fillings.

Understanding the difference and noticing how to categorize your workers helps companies stay compliant and avoid costly mistakes. In this episode of Compliance Corner, Casey Walters, isolved Senior HR Business Partner, answers some of the most commonly asked questions about tax form W-2 and 1099.*

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What is the difference between a 1099 and W-2 form?

A W-2 form is issued to employees and details their wages, taxes withheld, and other payroll information for the year. This form is used to report income to the IRS and includes information on federal tax, Social Security, and Medicare taxes. Employers are responsible for withholding these taxes from the employee’s paycheck.

A 1099 form, specifically a 1099-NEC, is issued to independent contractors and freelancers who have been paid $600 or more for their services. Unlike W-2 forms, 1099 forms do not withhold taxes. Contractors are responsible for managing their own tax payments, including self-employment tax. This form reports non-employee compensation to the IRS and helps freelancers and gig workers report their income accurately.

What is the difference between form 1099-MISC and form 1099-NEC?

Form 1099-MISC is used to report various types of miscellaneous income, such as rent, royalties, and other forms of non-employee compensation that don’t fit into other 1099 categories. This form covers a broad range of income types, making it essential for reporting diverse payments made by businesses throughout the tax year.

Form 1099-NEC specifically reports non-employee compensation. This form is used to report payments of $600 or more made to independent contractors and freelancers. The IRS separated non-employee compensation into its own form starting in the 2020 tax year to streamline reporting and reduce confusion, making it easier for business owners and the internal revenue service to track this specific type of income.

When should an employer use a 1099 form vs. a W-2 form?

1099s and W-2s are the tax forms employers use to report wages and taxes withheld for different workers.

Employers should use a W-2 form for employees who were hired internally, receive regular wages and employee benefits. These employees have taxes withheld from their paychecks, including federal tax, state income taxes, Social Security, and Medicare taxes. Employers use a W-2 tax form to report an employee’s wages and payroll taxes withheld, which gets submitted to the Social Security Administration (SSA) and the IRS.

1099 workers are also known as self-employed workers or independent contractors or freelancers who are paid $600 or more in a tax year. These workers do not have taxes withheld from their payments; instead, they are responsible for their own tax obligations, including self-employment tax. The 1099 form reports the total non-employee compensation to the IRS and is essential for contractors to file their tax returns accurately.

How can employers determine the classification of an employee?

Employers can determine the classification of an employee by assessing the type of relationship and the level of control over the worker. The IRS uses three primary categories for this assessment: behavioral control, financial control, and the type of relationship.

• Behavioral: Does the company control or have the right to control what the worker does and how the worker does their job?
• Financial: Does the company or payer control the business aspects, like how it pays the worker? Are the worker’s expenses reimbursed? Who provides the tools and supplies needed to get the job done?
• Type of relationship: Do you have employee policies or offer employee-type benefits like pension, insurance and vacation pay? Is the work performed a key aspect of the business? Will the relationship continue once the work is done?

The type of relationship is determined by evaluating written contracts, employee benefits, and the permanence of the relationship. If an employer provides benefits like insurance, retirement plans, and direct deposit for wages, the worker is more likely to be classified as an employee. On the other hand, if the worker is hired for a specific project or period without ongoing obligations, they are more likely to be classified as an independent contractor. Correctly classifying workers ensures compliance with tax purposes and avoids potential penalties from the IRS. It is also important to remember that each state has rules and regulations around worker classifications. Unfortunately, no one factor can make that determination.

Why is it important to prevent misclassification of employees?

Preventing misclassification of employees is essential to comply with federal and state tax laws. It is important to know the difference between 1099 independent contractors and W-2 employees for a few reasons, including:

1. Misclassifying an employee as an independent contractor can result in financial penalties from the IRS, as well as back taxes for unpaid FICA taxes and income tax withholding, or an employee misclassification lawsuit against your business.
2. Employee classifications affect how both you and your workers are taxed. You are required to withhold income taxes and pay taxes on the wages you pay to W-2 employees. You do not usually have to withhold or pay taxes on the payments you make to 1099 contractors.
3. Employee classifications determine how much control you have over a worker’s schedule, payment and other aspects of their job. Independent contractors define when, how and where they work. Employees work according to your schedule and policies.
4. Misclassification also impacts the employee’s benefits and protections. Employees misclassified as contractors may miss out on unemployment insurance, workers’ compensation, and other benefits such as health insurance and retirement plans.

Ensuring proper classification protects both the employer and the worker, fostering a compliant and fair working environment.

What should employers be aware of when hiring a contractor instead of a full-time employee?

There are several things employers should take into consideration when deciding whether to add a contractor or a full-time employee to their team.

For starters, working with independent contractors allows employers greater leeway in hiring and releasing workers, but employers should be aware of the differences in tax obligations and employment laws. Contractors receive a 1099 form, not a W-2, and are responsible for their own tax payments, including self-employment taxes. Employers do not withhold taxes or provide benefits such as health insurance, retirement plans, or unemployment insurance for contractors. Many employers use independent contractors only as needed for relatively short-term projects.

Keep in mind that while this means there is greater flexibility, the coming and going of contractors can also be disruptive to the rest of the workforce. Another thing to be aware of is that employers have less control over contractors. Unlike employees, whom you can closely supervise and monitor, independent contractors have a certain autonomy to decide how best to do the task for which you hired them.

What should employers know about the salary and benefit differences for 1099 and W-2 workers?

In addition to the differences between contract and full-time employment agreements described above, for full-time employees, employers withhold certain amounts from their W-2 employees’ paychecks at both the state and federal level to pay taxes—easing the tax burden on their employees.

Employers are required to provide certain benefits to their W-2 employees based on various company characteristics. Full-time employees receive a regular salary and benefits such as health insurance, retirement plans, and unemployment insurance. These employees have taxes withheld from their paychecks, including Social Security tax, Medicare tax, and federal and state income taxes. Employers are responsible for paying a portion of these taxes and must file form W-2 to report the employee’s wages and tax withholdings. For a W-2 employee, the employer pays 7.65% of Medicare and Social Security taxes while the employee pays 7.65%.

Independent contractors also do not have access to employer-sponsored health, dental, life and disability insurance plans. Gone is the 401(k) plan with the employer match. The contractor bears full responsibility for finding affordable benefits, which is a formidable challenge for the self-employed. This means going out and buying a disability insurance policy and funding a retirement plan, among many other things.

For independent contractors who file a form 1099 at tax-time, the contractor becomes liable to pay the employer’s share of these taxes, meaning that the full 15.3% comes out of each client payment the contractor receives. This is in addition to the income tax and self-employment tax independent contractors are required to pay. They are paid based on the terms of their contract, employers do not withhold taxes from their payments, and they are responsible for paying their own taxes.

What is the difference between a W-2 vs 1099 employee for small businesses?

For small businesses, the key difference between W-2 and 1099 employees lies in their employment status and tax obligations. W-2 employees are considered full-time or part-time workers who receive regular wages and benefits. Employers withhold taxes from their paychecks, including federal income tax, Social Security tax, and Medicare tax. Employers also contribute to these taxes and must provide benefits such as unemployment insurance.

1099 employees, or independent contractors, work on a contract basis and are not on the regular payroll. They are responsible for their own tax payments and do not receive benefits from the employer. Small businesses issue a 1099-NEC form to report non-employee compensation to the IRS. This classification can save businesses on payroll taxes and benefits, but it is crucial to correctly classify workers to avoid penalties and ensure compliance with tax laws.

How should W-2 and 1099 forms be delivered to employees?

W-2 forms must be delivered to employees by January 31st of each year. Employers can provide these forms in paper format, mailed to the employee’s address on file, or electronically through a secure online portal. For electronic delivery, employees must consent to receive their forms this way, and employers must ensure the security and confidentiality of the data.

1099 forms should also be delivered to contractors by January 31st. Similar to W-2 forms, 1099 forms can be mailed or delivered electronically. Electronic delivery requires the contractor’s consent and must comply with IRS guidelines to ensure the privacy and accuracy of the information returns. Employers should use a reliable method to track the delivery of these forms to ensure compliance and proper documentation.

What are the benefits of sending W-2 forms electronically?

Sending W-2 forms electronically offers several benefits for both employers and employees. For employers, electronic delivery reduces administrative costs associated with printing and mailing paper forms. It also minimizes the risk of forms being lost or delayed in the mail, ensuring timely delivery and compliance with IRS deadlines. Additionally, electronic delivery supports e-filing, streamlining the submission of information returns to the IRS.

For employees, receiving W-2 forms electronically provides quicker access to their tax information, which can be particularly useful during tax season. Employees can easily retrieve their W-2 income data, including identification numbers, through a secure online portal. This convenience aids in managing business expenses and preparing for tax filings. Electronic forms can also be imported into tax preparation software, simplifying the process of filing an IRS form and potentially expediting a tax refund. For those wondering how to get a W-2 online, employers typically provide access instructions, ensuring employees can access their tax statements efficiently.

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About Casey:

Casey is part of isolved’s People Services team and has more than ten years of experience in HR. His areas of expertise include employee relations, performance management, benefits management and safety. Throughout his career, Casey has worked within the manufacturing, marketing, medical, banking and finance industries.

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* This blog is not legal advice. Please seek proper legal advice.

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