In general, there are two main ways an employee can be classified a W-2 employee or a 1099 worker. Both the W-2 and 1099 are tax forms that are used to report income to the IRS, but each is unique and it’s important for your business to make sure employees are classified correctly, and that the correct form is being used. To ensure you’re using the appropriate classification, here are the main differences between a W-2 and 1099, and the potential issues that arise if they are misclassified.
What Is a W-2 Employee?
A W-2 employee is just that – an employee. A W-2 employee is employed full-time or part-time by your company directly and receive regular pay and benefits through the company’s payroll, as well as work according to the business’s schedule and policies. With W-2 employees, employers are required to withhold Social Security and Medicare taxes, as well as file payroll withholding tax. W-2 employees also need to be provided with the resources and tools necessary to complete their job duties. These employees will receive a Form W-2 from their employer for the time worked during the previous year for tax purposes.
What Is a 1099 Worker?
A 1099 worker is someone who is self-employed and often referred to as an independent contractors, freelancers, or gig workers. A company would typically hire this type of worker for a specific job duty, project, or task that has a defined, written contract. This worker supplies their own resources and tools to complete the task, can work for multiple businesses (clients) at once, and can even hire their own workers to assist with completing the task. The business that contracts the 1099 worker is not required to withhold any taxes or file any taxes on this worker. The 1099 worker will file and pay their own taxes. The business also does not need to offer any benefits to a 1099 worker that they would a W-2 employee.
Tax Differences Between W-2 and 1099
The tax implications for a business employing a W-2 employee is much different than when hiring a 1099 worker. A 1099 worker will be paid per the terms of their contract, and they receive a 1099 form at the end of the year to report their income for the year. Business owners who hire a 1099 do not need to file or withhold taxes on 1099 workers. Since these workers are self-employed and contracted, they are responsible for paying and filing their own taxes, as well as providing their own benefits.
W-2 employees on the other hand, are regularly employed by the business. They receive regular wages, are on the company’s payroll, and receive employee benefits offered by the company. In the case of a W-2 employee, the business must withhold the appropriate taxes and report/file those payroll taxes to the IRS on a W-2 form. In addition, the business must deposit federal income taxes, unemployment taxes—federal and state—and Social Security and Medicare taxes for the employer portion and employee portion. The business must also report any additional employee wages, tips, or other compensation.
Using the Appropriate Form
The IRS offers some common-law guidance on how to determine if a workers should receive a W-2 or 1099. There are three main categories to consider: behavioral, financial, and relationship.
- Behavioral: Does the company control, or have the right to control, what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (These may include how the worker is paid, whether expenses are reimbursed, who provides the tools and supplies, etc.).
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue, and is the work performed a key aspect of the business?
Businesses should weigh all factors when determining whether their worker should receive a Form 1099 or a Form W-2.
What Happens If a Worker Is Misclassified?
The way a worker is classified directly affects the taxes of the worker and the employer. Misclassifying a worker can result in IRS audits, fines, and even employment lawsuits from the misclassified worker. When an employee is misclassified, state and federal authorities lose out on tax amounts, leading to a potential IRS audit that could result in large fines for the business. Employers could be responsible for paying state and federal payroll taxes, as well as Social Security and Medicare taxes, for any employee found to be classified incorrectly. If a worker should be a W-2 employee, but was classified as 1099, the employer will also face fines for failing to collect a Form I-9 for that worker, as all W-2 employees must have a correctly completed I-9 on file.
There is also the potential for wage claims. If an employer misclassifies an employee, they are potentially violating wage, tax, and employment eligibility laws. Businesses can be held liable for failing to pay overtime and minimum wage under the Federal Fair Labor Standards Act (FLSA), in addition to state-specific wage and labor laws. Wage claims can even go as far back as three years if a violation is found to be legitimate.
If you’re needing assistance on whether to hire a 1099 or W-2 worker, or are looking for guidance on classifying existing workers, SBS PayrollHR and our team of experts is here to help. Through our robust human resource solutions, we provide expert guidance and up-to-date industry knowledge, so you can feel confident you are receiving the best and most accurate advice. Our payroll team is knowledgeable in all things payroll tax-related and are available to assist with any questions you might have on employee and employer taxes as it relates to W-2s and 1099s.