Tax season can be an interesting time of year for business owners. Doing your part as an employer means that it’s important to be familiar with your tax forms, especially W-2s and 1099s, so that you can get your workers the right tax information on time.
What’s the Difference?
The short answer is that both forms are wage statements representing different types of worker classifications. A W2 goes to employees, and a 1099 goes to contractors. The fundamental difference between the two types of workers is whether or not the employer controls the workflow or whether they control the outcome.
• Contractors: Are responsible for the end result, but are typically not answerable for the process. Employers often don’t control the workflow.
• Employees: Have their workflow and work conditions dictated by an employer.
Obviously, you can get deeper into it than that. With an employee, the employer must withhold income taxes, social security, and Medicaid taxes, whereas earnings from independent contractors are subject to the self-employment tax.
The Three Key Identifiers
Generally speaking, IRS looks at three key areas to determine if a worker is an employee or a contractor:
• Behavioral: Does the employer control the worker’s time and how they do their job?
• Financial: Does the employer control business aspects of the worker’s job, such as how the worker is paid, whether expense are reimbursed, and whether the worker brings their own tools?
• Type of relationship: Does the worker have written contracts or employee benefits? Is the work ongoing and is it a key part of the business?
If you can’t tell whether you have a contractor or an employee, you can file a SS-8 form with the IRS, and they’ll formally make the determination for you. Try and plan ahead if you intend to use this option.
What Are You Reporting?
Whether you use the 1099 or the W-2, employers need to report different items to the IRS.
• W-2: Report wages, tips, and other compensation paid to any employee. This includes income and social security taxes. You’ll also need to report wages and withholding information to the Social Security Administration.
• 1099-MISC: Report payments of $10 or more in gross royalties or $600 or more in rents or compensation to the IRS and the contractor.
Follow the Rules
The IRS has guidelines and common law rules that help businesses accurately classify their workers, and you should take the determination seriously! Misclassifying a worker can give employers an increased tax bill or even a penalty fine, and the Fair Labor Standards Act allows the IRS to hold employers liable for unpaid overtime for misclassified workers.
Make sure you keep good documentation in case there are any legal disputes down the line, especially if you work with contractors. Because contractors are so much cheaper for businesses than hiring a full-time employee, the IRS is more likely to take a second look at your paperwork if you use them.
If you have specific questions about your employees, talk to a tax professional to make sure you’re issuing the right return for your staff!