Compliance Corner: Q&A on 1099 vs. W-2 Tax Forms
Friday July 30th, 2021
Estimated time to read: 3 minutes, 15 seconds
Employers are required to issue tax forms to their employees each year – and making sure you are issuing the correct tax form is important to avoid potential penalties from the IRS.
In this month’s Compliance Corner blog, HR Business Partner for isolved People Services Casey Walters is answering questions about 1099 and W-2 tax forms. Find out what you should know by reading the Q&A below:*
1. 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. 1099 workers are also known as self-employed workers or independent contractors. These workers receive a 1099 form to report their income on their tax returns.
W-2 workers are also known as employees. Your company employs these workers directly, and they receive regular pay and employee benefits. Employers use a W-2 tax form to report annual compensation and payroll taxes withheld from their compensation.
2. How can employers determine the classification of an employee?
There is no magic formula to determine whether a worker is an independent contractor or an employee, but the IRS does offer some guidance. Three categories determine the degree of control you have over a worker:
• 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?
Employers have the responsibility to weigh the above factors when determining whether a worker is an employee or an independent contractor. It is also important to remember that each state has rules and regulations around worker classifications. Unfortunately, no one factor can make that determination.
3. Why is it important to prevent misclassification of employees?
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 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. 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. 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.
5. 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. Employees usually expect benefits like health insurance, paid time off, overtime pay and other perks.
For a W-2 employee, the employer pays 7.65 percent of Medicare and Social Security taxes while the employee pays 7.65 percent. 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 percent comes out of each client payment the contractor receives. This is in addition to the income tax independent contractors are required to pay.
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 of 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.
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.
* This blog is not legal advice. Please seek proper legal advice.
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