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If you’re an employer hiring workers, you’ll have to make a decision about whether you bring someone on as an employee on the 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 receives a Form W-2 or a Form 1099-NEC will depend on their role at a company.
• W-2 workers are usually 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, while a 1099 contractor is responsible for paying their own taxes.
• It is the employer’s responsibility to offer the correct form to anyone they hire, or they could face financial or legal penalties.
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, either Form 1099-NEC or Form W-2. Freelancers, or independent contractors, will receive a 1099. Employees on the payroll will receive a W-2.
W-2 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 a salaried or hourly employee.
Employers typically have a lot of control over how W-2 employees work, including 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 guarantees, 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 work in an independent trade, business, or profession and supply services to the general public. For instance, this category could include professionals such as doctors, lawyers, accountants, or subcontractors who provide 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 or when work is performed. 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 vs. 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 take more tax deductions against the equipment, supplies, and other expenses related to their work.
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Employer Responsibilities
W-2 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, 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 the 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 refund. When it comes to income tax, the employer decides how much to withhold based on how the employee filled out Form W-4, the 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 their 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 or 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 when and how a worker does their job, 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 probably a W-2 employee. The same is true if they are offered company benefits.
If none of these situations apply, the hired employee is typically 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 are largely based on the relationship a worker has with 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 for paying 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 of scenarios in which you may have a W-2 and a 1099. It is common for people 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 forms 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. They typically do not have to pay estimated taxes quarterly.
Is it better to be a 1099 contractor or W-2 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 substantially at your company, your employer may switch you from a W-2 employee to a 1099 contractor. Your employer must ensure your new role adheres to 1099 classification and follow strict compliance rules from the IRS and the state.
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Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
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