If you're stuck asking yourself what the difference is between a 1099 and a W2, you're not the only one. Knowing when to use each correctly is an integral part of running a business, and misclassifying employees can come with legal ramifications you want to avoid.
The good news is you're in the right place to get answers.
Today, we will cover the basics of a 1099 and a W2, including when to use each.
(If you’re looking for a payroll solution you can start using right away, learn more about PayStubs here)
By the end of this article, you'll have a confident grasp of the differences between these two crucial documents and the key differences between contractors and employees.
Before we explore their differences, here's a brief definition of each form.
This form reports income other than wages, salaries, and tips received as an employee.
For this form, some common use cases include:
Independent professionals (such as consultants or freelancers)
For example, let's say you hired a web developer for your business on a one-time project. You would issue a 1099 to that contractor at the end of the year to report payments made to them throughout their work with you.
Unlike a 1099, a W2 reports wages and salaries paid to employees and taxes withheld from those payments. PayStubs makes it easy for you to create these forms based on things like the tax year and the state in which you operate.
If someone is a full-time, part-time, or seasonal employee of your business, you'll likely use a W2 to report their income and taxes.
An example might look like this: If you employ a full-time customer service representative, you will use a W2 to report the wages and taxes withheld from their paycheck each pay period.
Contractors vs. Employees: An Overview
We'll discuss the specifics of classifying workers later in this article. But for now, here's a brief overview of the differences between contractors and employees.
Generally, contractors work independently from a company, providing services to businesses without being an official part of the organization. Contractors are responsible for their own taxes and employment benefits (such as health insurance).
On the other hand, employees work as part of a business's staff and receive more traditional benefits such as health insurance or vacation time. They may also have withholding taxes taken out of each paycheck in addition to income tax filing requirements.
Now that we've reviewed the basics of these forms and which workers you use them for, let's closely examine their differences.
1099 versus W2: What's the Difference?
The truth is that 1099s and W2s are different documents with two primary differences: one applies to payroll employees. In contrast, the other applies to non-payroll workers, and they have different tax implications.
1. Payroll employees versus non-payroll workers
W2s apply to payroll employees, and 1099s are for non-payroll workers.
A payroll employee is generally an individual you pay for services through a traditional employer-employee relationship. This includes full-time, part-time, and contract employees.
On the other hand, non-payroll workers are independent contractors or freelancers the company does not employ. They typically invoice and receive payment from your business instead of taking a salary or hourly wage.
2. Tax implications
Another difference between W2s and 1099s is taxes: how much you must withhold from each paycheck and which forms you must file at tax time.
With a W2 employee, you must withhold federal income tax, Social Security tax, and Medicare tax. You'll also need to file a W-2 form at the end of the year. The W-2 form shows how much an employee made over the year and how much you withhold from their paychecks in taxes.
With a 1099 contractor, however, you won't usually need to withhold taxes since they are considered self-employed individuals. Instead, the onus is on the worker to estimate and pay the taxes they'll owe.
Businesses must provide 1099 contractors with a 1099 MISC form at the end of each year to show how much they were paid during that period.
3. Liability issues
Finally, it's important to note that there can be legal implications if you misclassify an employee as an independent contractor when they should be on your payroll.
Generally, if an individual performs services for your business and is under your control, you treat them as an employee.
You may be liable for back taxes, overtime pay, and more if you misclassify someone. So, it's essential to understand the difference between a 1099 and a W2 before classifying anyone.
That brings us to our next topic: classifying workers per IRS guidelines.
Classifying Workers Per the IRS Guidelines
The IRS has specific criteria for doing so. On the IRS website, they explain that the "facts that provide evidence of the degree of control and independence fall into three categories."
These categories are:
Type of relationship
In the case of behavioral control, the IRS looks at facts that show whether there is a right to direct or control how a worker does their job. This includes factors such as the type of instruction, the degree of instruction, evaluation systems, and training.
As for financial control, the IRS looks at facts indicating whether the business has the "right to control the economic aspects of the worker's job."
This includes significant investment, unreimbursed expenses, the opportunity for profit or loss, services available to the market, and payment methods.
Some factors that indicate a particular type of relationship include written contracts, employee benefits, permanency of the relationship, and services performed as a key business activity.
Recap: 1099 versus W2
1099 workers are independent contractors who generally invoice your business for their services. You likely won't need to withhold taxes from their paychecks, and you'll need to provide them with a 1099 form at the end of each year.
A W2 employee, on the other hand, is someone who works directly for your company in either a full-time, part-time, or contract capacity.
With this type of employee, you'll need to withhold federal income tax, Social Security tax, and Medicare tax from their paycheck. Additionally, you'll need to file a W2 form at the end of each year that shows how much money your employee made and how much you withheld in taxes.
W2 forms seem overwhelming initially, considering the paperwork you must complete and file. But PayStubs takes the guesswork out of the process!
Creating a W2 with PayStubs
With PayStubs, we automatically generate the needed W2 forms for you at the beginning of the year, for the pervious year.
All you'll need to do is use our system to run your payroll calculations throughout the year, and we will cover the rest.
Once we’ve created the W2 forms, you can download your Form W-2s in a PDF format that contains multiple pages.