A small business can quickly lose thousands of dollars if it needs to be more accurate in its workers. Workers who discover they are incorrectly classified can sue or turn to state/federal enforcement agencies for restitution. Besides financial penalties, misclassification can also hurt an employer’s reputation. Employees want to work for companies with good reputations that treat them well.
What is 1099?
1099 is a tax form that reports non-employment income, such as rental property profits, interest, dividends, capital gains, and miscellaneous income. Businesses are required to send copies of this form to workers and the IRS if the total compensation paid during a calendar year is at least $600. People who receive 1099 are sometimes called independent contractors, freelancers, or gig workers.
W-2 employees, on the other hand, are considered traditional employees. They are typically offered a salary, employee benefits like health and life insurance, income tax withholding, and worker-specific protections like minimum wage and workers’ compensation. W-2 employees must also abide by company rules, policies, and work hours. Using W-2 employees for projects with set start and end times is usually more convenient for companies because they can be matched to a specific job description. However, it can be risky to hire W-2 employees as full-time staff because there is no guarantee of future employment, and they may be unable to commit to the company for a long time.
On the other hand, independent contractors can be more flexible regarding their schedules and the kinds of jobs they accept. They often have a wide range of skills and can offer specialized expertise to benefit a business. Independent contractors can also help reduce costs by not requiring employers to provide them with employee-type benefits.
What is a W2?
A W2 is a tax form listing an employee’s year-end compensation and any payroll taxes withheld. Employees must receive a copy of this form by the end of January each year. It also includes a breakdown of the taxable wages, federal and Social Security tax withholding amount, and any pre-tax deductions like retirement contributions or health insurance premiums.
The IRS outlines three categories of facts to decide whether someone is a W2 employee. The first factor is whether the worker contributes to a company’s business. For example, a warehouse worker who regularly works shifts contributing to the business’s overall productivity would be considered a W2 employee. Another factor is whether the company controls when and where the worker does their work. This could be determined by scheduling, ongoing work, and the type of training or tools provided to workers. Finally, the third factor is whether the worker gets typical employee benefits like days off and a company-sponsored health plan.
If you need clarification on whether your workers are W2 employees or contractors, it’s important to speak with an accountant and legal counselor before making any changes. Misclassification can lead to steep legal and financial penalties for your business. This is why it’s crucial to correctly classify a new hire at the beginning of their relationship and reassess their status over time to ensure you aren’t risking your company.
What Is The Difference Between The Two?
The distinction is important because if you classify a worker as an employee and later find out they should have been classified as a 1099, your business could face steep penalties. Consider a worker’s classification from the start and then regularly reassess their role since a relationship may change over time. When determining the difference between 1099 and w2 workers, consider the following factors:
Independent contractors are hired to complete a specific task and typically have a contract specifying their work scope. They might also be expected to set their hours and deadlines for completion. However, because independent contractors are self-employed, they aren’t covered by worker’s compensation insurance in case of a workplace injury. You need to be aware of the difference between a 1099 and a W2 because worker classification affects how you record and report income for your workers. If you have employees correctly classified as such, the IRS will know how much to withhold from their paychecks for federal taxes, Social Security and Medicare taxes, and state income tax, if applicable. Independent contractors are responsible for filing their taxes using the information from the forms they receive from their employers. You should provide them with Form 1099-MISC to report their income.
Why Is It Important to Know The Difference?
It is important to know the difference between a 1099 and W2 because it can impact the amount of tax you must withhold for your employees and the payroll taxes you must pay. In addition, misclassifying workers can result in financial penalties if the IRS determines that you have incorrectly classified someone as a contractor when they should be an employee and, therefore, not paying employment taxes (including the employer’s share of FICA).
The primary way to distinguish 1099 from a W2 is by looking at the individual’s work history with your business. Independent contractors receive a 1099-MISC for their income, while employees get a W-2 form each year. However, there are instances when the same worker could be both a W2 and 1099 at different times during the year – such as if they were hired as an independent contractor before being converted to a full-time employee later. Despite the complexity of classifying your workforce, several resources are available to help you. For example, the IRS has a worksheet that you can use to evaluate whether a person is an employee or an independent contractor. You can also use Publication 15-A, the Employer’s Supplemental Tax Guide, to help you decide how to classify new hires. It is essential to reassess your workforce classification periodically since the nature of a person’s relationship with your business can change over time.
