Whether you issue a W-2 or 1099 to a worker depends entirely on their classification (independent contractor vs employee). Due to the difference in the forms and classifications, getting it right is critical to avoid legal issues and penalties. Read on to learn more about the key difference between 1099s and W2s, including tax implications, benefits, and employer responsibilities.
What is a W-2 Tax Form?
A W-2 form is a tax document employers are required to provide to each employee and the IRS annually, summarizing the employee’s wages and tax withholdings for the year. W-2 employees receive a regular wage or salary, and their employer withholds income taxes, Social Security, and Medicare taxes on their behalf.
What is a 1099 Tax Form?
A 1099 form is used for independent contractors, who are self-employed workers providing services to a business. It reports payments made to non-employees and is provided both to the contractor and the IRS. Unlike W-2 employees, 1099 workers don’t have taxes withheld by their employers and are responsible for handling their own tax obligations.
Tax Implications
A 1099 or W-2 must be issued to any independent contractor or employee who earns $600 or more in a year. The requirements and tax implications differ though.
A freelance worker is responsible for paying all of their federal and state and local taxes, as well as Social Security and Medicare (FICA) taxes. The employer utilizing a freelancer doesn’t withhold taxes and simply reports what they’ve paid to the freelancer on the 1099.
For W-2 employees, the employer is required to withhold taxes for the employer and employee portions. This includes federal income tax, state and local taxes (where applicable), and Social Security and Medicare taxes. The employer may be responsible for additional payroll taxes, such as unemployment insurance. The W-2 documents wages earned and taxes withheld.
Benefits and Protections
Another key difference between W-2 and 1099 workers is that W-2 workers are benefit-eligible. They are often offered health insurance, retirement plans, paid time off, and other company benefits. They also receive protection under labor laws, including minimum wage and overtime requirements.
While a 1099 enjoys a flexible schedule, they don’t receive typical company benefits. They are responsible for paying the full portion of taxes and have limited legal protections compared to W-2 employees.
Employer Considerations
Due to onboarding costs, payroll taxes, and benefits, a W-2 employee typically costs a company more than using the services offered by a 1099 contractor. But there are some important considerations if you choose to save money by utilizing a freelancer.
A 1099 worker gets to choose when they work and their work methods, meaning employers have less control and oversight. A W-2 employee is fully integrated into the company’s operations, following set schedules and procedures.
While W-2 employees provide stability and consistent coverage, 1099 contractors offer workforce adaptability for changing business needs.
Common Misclassifications and Penalties
Employers sometimes misclassify workers unintentionally, either due to a misunderstanding of the rules or to avoid payroll taxes and benefits costs. However, the IRS and Department of Labor closely monitor worker classifications, and mistakes can lead to audits, fines, and back payments of wages and taxes.
One common misclassification occurs when an employer exerts significant control over a 1099 worker’s schedule, tasks, and work processes. If a worker is required to follow specific instructions, work set hours, or use company-provided tools, they should be properly classified as a W2 employee.
Penalties for misclassification can be severe. Employers may be required to pay back payroll taxes, along with interest and penalties. In some cases, they may also be responsible for covering unpaid overtime wages and employee benefits. If the misclassification is found to be willful, additional fines and legal action may follow. To avoid these risks, businesses should carefully assess each worker’s role, consult IRS guidelines, and, if necessary, seek legal or tax advice to ensure proper classification.
When to Use W-2 vs 1099
Whether you hire W-2 or 1099 employees depends on your company needs. For long-term, full-time positions in which you want more control over the employee’s work, you should hire a W-2 employee. For project-based or temporary work arrangements, a 1099 worker may fit the bill. Some businesses employ a mix of W-2 and 1099 workers to fulfill operational needs.
How Paycor Helps
Paycor’s Payroll solution comes with built-in compliance to streamline classifying and paying workers, whether you need to withhold taxes or not. When it comes to tax processing, Paycor handles all the details, including W-2 and 1099 processing. Take a guided tour to learn more.