It’s a big step for any business to hire an employee. Starting with contractors or gig workers could be a smart step to help your business grow without taking on the responsibility of full-time employees—but you have to know the legal distinctions to avoid misclassifying employees.
We compared the 1099 vs W-2 forms, so you can quickly determine which you need to use and when to use it. Here’s what you need to know.
Difference between 1099 and W-2 workers
Are you trying to understand the difference between 1099-MISC and W-2? These are nothing but different kinds of employment. 1099 refers to individual contractors, and W-2 refers to employees on the payroll.
A major function of the HR operation of any company or organization is to understand what kind of workers they need to achieve optimum results. Some businesses may need just W-2 employees or just 1099 employees. A hybrid setup may have a combination of 1099 and W-2 workers. 1099 and W-2 are tax forms, based on the kind of employment – full-time or part-time. 1099 is relevant for contract workers whereas W-2 is for full-time workers. A business could be a mix of full-time and part-time workers, based on the nature of the work. A 1099 – MISC tax form is filed by the individual himself, whereas a W-2 form is filed by the employer on behalf of the worker as he is a part of the payroll. It’s extremely important to understand the classification of workers because it impacts the way they are taxed. For instance, the employer takes care of the Social Security and Medicare taxes for ‘on the payroll’ employees.
What should you know about W-2 employees
A W-2 employee wages could be hourly or monthly, and he isn’t committed to any specific tasks as such. He is on the payroll, and a part of the company, and hence entitled to benefits like vacations, sick days, pension, health insurance and more, all of which have to be taken care of by the employer. He is also eligible for worker’s compensation insurance, and unemployment insurance. As the committed help of the company, he is entitled to the employer taking care of his tax withholdings. In other words, the employer withholds the taxes, and manages and files tax returns on behalf of the employee.
Understanding a W-2 form will clarify the positioning of a W-2 employee much better.
A W-2 form is sent by an employer on behalf of their employees every year, to report the wages paid to employees in a year. Employers must provide W-2 forms each to the employee and IRS.
The W-2 form includes information related to the employee’s taxes and that includes:
- State Income: Whether any amount has been withheld for state taxes
- Taxable Income: How much the employee’s wages are, and how much of it is withheld as federal taxes
- Social Security and Medicare Income: How much of the employee’s wages are withheld for FICA taxes
- FICA is a U.S. federal payroll tax. It stands for the Federal Insurance Contributions Act and is deducted from each pay check. Taxes under the Federal Insurance Contributions Act (FICA) are composed of the old-age, survivors, and disability insurance taxes, also known as social security taxes, and the hospital insurance tax, also known as Medicare taxes. Different rates apply for these taxes.
The W-2 form is given to any employee who is paid at least a wage of $600, regardless of the work performed. The employer then files their W-2 form to taxation authorities, IRS, SSA, wherever applicable.
Employers have to support the W-2 workers with all the tools and supplies needed. They are also entitled to business expenses they incur over the course of their employment. While W-2 employees are entitled to more fringe benefits, they have lesser autonomy over their work, and the employer benefits consistently. They are obligated to take on assigned tasks associated with their job role, and their role and career path are defined by the company. The whole approach is more role-oriented as opposed to being task oriented. Employers are entitled to judge the employee’s performance, and define their compensation benefits accordingly. W-2 employees are also subject to being fired
You may need a W-2 employee if:
a. You need a committed worker to help you handle the workload
b. Your business needs a worker who is available during fixed hours
c. You are in a position to handle an individual’s compensation package inclusive of his social benefits
What should you know about 1099 employees
A 1099 employee is hired for specific or specialized tasks, for a fixed amount of time, on a contractual basis, and is paid per task accomplished. An employer doesn’t have to deal with the liability of providing other benefits, like healthcare and insurance to a 1099 employee. The burden of a contract employee on a company is much lower than that of a full-time employee. 1099 employees are the best way to go if your business involves seasonal work or needs a specialist, for instance, tourism, or commissioned artwork. A 1099 worker also takes care of his own tax withholdings, that is, he takes care of his tax filing and returns on his own.
The 1099 isn’t a form, but a series of forms. There are different types of 1099 tax forms – the IRS refers to them as ‘information returns’ based on the kind of financial disclosure it contains.
Here’s a rundown of the Form 1099s most likely to cross your path.
- 1099-K: If you’re a freelancer or a small business owner, and you’ve received $600 worth of business income from a client via credit card or a third party system (e.g. Venmo, Cash App), the summary of those payments will be sent to you through a 1099K.
- 1099-DIV: This tax form is a record that a company or other entity paid you dividends. If you earned more than $10 in dividends from a company or other entity, you’ll receive a 1099-DIV. A 1099-DIV is a common type of IRS Form 1099, which is a record that an entity or person — not your employer — gave or paid you money.
- 1099-MISC: A 1099-MISC tax form is a type of IRS Form 1099 that reports certain types of miscellaneous income. The 1099-MISC is a common type of IRS Form 1099, which is a record that an entity or person — not your employer — gave or paid you money. You might have received a 1099-MISC tax form from a client in the past if you’re a freelancer, independent contractor, or self-employed. However, starting in 2020, those payments are now reported on the 1099-NEC instead.
- 1099-NEC: In 2020, the IRS revived the 1099-NEC form for reporting nonemployee compensation. In other words, if you freelanced, were self-employed or had a side gig, your clients should send you a Form 1099-NEC instead of a Form 1099-MISC. As always, you’ll use the information on that form to prepare your tax return.
A 1099 worker is less expensive for an employer, as compared to a full-time employee. There is also a lesser amount of emotional commitment in terms of the employee’s career growth and performance. It’s a given that a 1099 worker will bring a certain level of quality of work to the task at hand, and these terms can be pre-decided.
Typically a 1099 worker could be any of the following.
- Gig workers who perform on-demand, temporary jobs, like hosting events or selling concert tickets and concession
- Freelancers who set their own rates and accept assignments per their choice, like wedding photographers, copywriters, graphic designers, and musicians.
- Independent contractors like lawyers, financial consultants
- Consultants who are experts, and are typically paid handsomely to give specialized advice, like advertising agencies, HR consultants, audit firms and digital marketing agencies.
Do you need a 1099 or a W-2 employee?
The IRS provides basic guidelines to help delineate employee classification.
- Behavioural: How much control does the company have over what the worker does and how they do it?
- Financial: Who provides the resources for the worker (such as tools and supplies)? Does the employer determine how the worker is paid? Does the employer determine reimbursements?
- Type of relationship: What does the employment contract look like? How long will the relationship last? How essential are the workers’ tasks? Does the employer offer benefits?
There are penalties for misclassification, to avoid employers taking advantage of the lower cost of a 1099 worker while demanding the same benefits of a W-2 employee. There are assigned government entities like the IRS, the Department of Labour, and other designated state agencies, to avoid the misclassification of workers. Penalties can go as far back as three years; and are more severe if it’s proven that the business intentionally misclassified workers.
Conclusion
To summarize, as an employer you can decide what works best for you, just 1099 workers, W-2 workers, or a combination of both. A business may need a few committed workers to handle the regular workload, and a few contractual workers to handle specific tasks. Since any company or business is a complex machinery, and even the most accomplished business owner can’t make these decisions on their own, it is best to consult professionals. Employment attorneys and tax professionals can help you with your final decisions, on how to create your business’s workforce.
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