1099 vs W-2: The Difference for Employers

Employers use form 1099-MISC to inform the IRS how much they paid a contractor. This form contains many important pieces of information like a contractor’s tax identification number, employer address, section 409a income, and any withheld taxes. There are many different types of workers from temporary, full-time, part-time, to freelancing/gig economy work. Yes, the gig economy (think driving for Uber/Lyft, delivering food with GrubHub, and more) is skyrocketing with many Americans partaking.

Whether you’re an employer or a worker, it’s worth giving some thought to 1099 vs W-9 forms and the distinction between employees and contractors. Depending on your money-making activities, you may receive a few different 1099 forms to track your income. For example, you might receive a 1099-K form, which is used for payments via settlement entities (like PayPal) to record your business transactions for the year. Use the sum total of your 1099 forms to calculate your total income and AGI. Here are some tips to decode these two forms and what to expect when preparing your taxes. 1099 and W-2 forms are both common small business tax forms, but the differences include who receives the forms and how they are handled regarding tax rates and practices.

What are the typical tax rates for 1099 contractors and W-2 employees?

She started her career writing and editing content about home warranty, renters insurance, homeowners insurance and other home services topics before transitioning to home improvement products. She has spent the last year and a half working at a software company, managing content about CRMs, project management tools and other tech topics. Sign up to receive more well-researched small business articles and topics in your inbox, personalized for you. According to the IRS, there are three main questions to ask yourself when classifying 1099 vs W-2 team members at your business. Note that, in general, only one of the questions has to fit the bill for a worker to be considered an employee.

But businesses should be careful about changing worker classification from employee to independent contractor or vice versa, particularly if the person continues to perform the same work in the new status. You must adhere to minimum-wage, overtime pay and health benefits laws. You must also withhold employment and income taxes and pay the company’s portion.

Credits & Deductions

Some consultants, like lawyers paid on a monthly retainer, are highly compensated, while designers doing infrequent logo designs aren’t. Contractors usually have specific skills and focus on one to two niches. As previously mentioned, W-2 employees have stable and predictable income. They can set their hours and choose their clients, but their income varies from month to month based on how much work they do for how many clients. Whether you’re an individual considering a new role or a business owner deliberating hiring strategies, understanding W-2s and 1099s is vital.

You must provide a copy of this form to the contractor by January 31 of the year following their payment. While contractors tend to jump from gig to gig, employees stay with the company. The longer they stay, the better they understand your business objectives and brand.

Employees require more time and effort

You are required to withhold Social Security and Medicare taxes and file payroll taxes for W-2 employees. Additionally, it’s up to you to provide your employees with the tools and supplies they need to get their jobs done. W-2 employee is the default classification for any worker you can’t classify as a 1099 contractor. In cases where the IRS finds that the employer intentionally disregarded the rules for proper employee classification, the penalties are even steeper—up to $1,000 per misclassified worker and one year in prison. The employer could also face additional fines for failing to provide employee benefits like health insurance, retirement, unemployment, and workers’ compensation.

Independent contractors are normally people in an independent trade, business or profession in which they offer their services to the public. Some of the best industries for freelancers include seasonal industries like summer swim lessons and retail. Usually, businesses that have temporary booms and busts can benefit from w2 versus 1099 contractors. Another example includes an accounting firm hiring freelance tax preparers for only tax season. The business can end the contracts once the busy cycle is complete, which allows it to save money. If these tax preparers were employees, the business would waste money by having them sit in an office and not work.

W2 vs. 1099: Employee differences

For one thing, they won’t have to pay for all the benefits they would offer employees, such as health insurance and perhaps life insurance, not to mention bonuses, stock options, 401(k) plan contributions, and so on. For 1099 workers, you may pay them a set amount, either hourly or by the project. Many contractors will outline their payment terms and rates in their contracts. 1099 contractors who get paid hourly may ask for a higher hourly rate than you pay your regular employees.