What Is the Difference Between a 1099 and a W2 Tax Form?

According to the 2018 Small Business Profile, there are 30.2 million small businesses in the United States who employ 58.9 million people. As the owner of a business, you may be wondering, “What is the difference between a 1099 and a W2?”

Keep reading to find out everything you need to know about the different types of payroll to help determine the better option for you in paying your employees.

What Is the Difference Between a 1099 and a W2?

Both the 1099 and the W2 provide wage information for the purposes of the worker filing their income tax. The difference is in the taxes that need to be withheld from those payments, your business obligation to pay taxes, and the status of the employee as it relates to your business.

1099 Forms

When a person is not an employee of your firm but is an independent contractor performing work for you, they are presented with a 1099 form at the end of the year.

According to the IRS, to be an independent contractor the business making the payment can only control or direct the end result of the work being performed. They do not have the right to direct how the work is performed. The person performing the work is considered to be self-employed.

The 1099 form provides information on what income the person was paid for their work. You must provide a 1099 to every person to whom you pay $600 or more during the year.

From an employer standpoint, you have less control over the work performed by the person you have hired, but you have also eliminated your obligation to pay taxes as an employer of that person. No taxes are withheld from wages paid on a 1099.

New in 2020

If you have been using form 1099-MISC that is good for wages paid through 2019. Beginning in 2020 you must use Form Form 1099-NEC, which will be due on February 1, 2021.

W2 Forms

The W-2 form is issued to your employees for the purpose of filing their annual income tax returns. Any person who fits the classification of an employee receives a W-2.

The classification of an employee is any person who works for your business in exchange for compensation and is subject to your direction on how to perform their job. If a person meets these qualifications, they are an employee and are subject to the payroll tax code rules.

At the end of the year, many employers simplify this process by using a W2 maker,  allowing them to easily create this necessary form in an expeditious manner.

The W2 form provides the employee and IRS with information on the wages, tips, and other compensation the business paid to the employee. It also includes information on each state tax, federal tax, insurance, social security, or other withholding made from payroll during the year.

New in 2020

There are changes that have taken place in the withholding rules for 2020. This includes an updated W4 form that your new employees must complete for you to withhold taxes from their wages.

In the past, employees were able to claim personal and dependency exemptions on their withholding. This is no longer allowed. The new W4 incorporates a five-step process.

1. Employee name and filing status
2. Option for an employee to increase their withholding amount to accommodate higher taxes due to additional earnings from other jobs
3. Option for an employee to decrease withholding based on credits they will claim on their tax return
4. Option for an employee to increase or decrease their withholding amount based on deductions or other income they will report when filing their income tax return and may also increase the amount of federal income tax being withheld each pay
5. Employee signs the form

If the employee does not complete steps 2-4 you will withhold taxes based on the standard deduction for their filing status and tax rates will not have any adjustments.

If an employee was completed a W4 prior to 2020, you may continue using the information on that form for withholding. If the employee changes their withholding they must complete a new 2020 form.

If an employee does not provide you with a W4 form, they are to have taxes withheld as if they checked a box for single or married filing separately and made no requests for adjustments in steps 2-4.

Medicare and Social Security 2020

The Medicare tax rate is 1.45% each for employee and employer and has no base wage limit. The Social Security tax rate is 6.2% each for employee and employer and has a wage base limit of $137,700.

Exercise Caution

It is important to make sure you classify your workers properly as either employees or independent contractors. If you fail to use proper classifications you may be penalized. This includes violations under the Fair Labor Standards Act (FLSA) regarding unpaid overtime for misclassified workers.

It is not recommended to consider employees’ independent contractors as a way of avoiding employer obligations. The IRS does not require you to withhold or pay taxes for independent contractors.

For employees, you are required to pay unemployment tax. You must also withhold Medicare and Social Security, plus state and federal income tax.

If you are not sure how to classify the people working for you, complete Form SS-8 “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.” The IRS will determine the proper classification for your workers.

Legal Ramifications of Misclassifying Employees

If you have someone working for your company on a 1099 who should be working as an employee, you are violating the law and can be costly.

If you fail to properly classify an employee and show them as an independent contractor, you may suffer expensive penalties from both the Internal Revenue Service and the United States Department of Labor.

If the IRS determines that you have an employer-employee relationship with the worker, then that person’s wages are subject to income tax withholding and FICA withholding. Penalties for failing to classify them as an employee include but are not limited to:

• $50 fine for each W-2 Form you did not file on the employee
• A penalty of 1.5% of the employe’s wages plus 40% of the FICA taxes you did not withhold from the employee’s wages
• 100% of the matching FICA taxes you as the employer should have paid

Use Good Business Sense

Now that we have answered the question “What is the difference between a 1099 and a W2?” use solid business logic in determining how to classify your employees. Trying to avoid payment of business taxes by classifying workers under 1099 status can be a costly mistake.  

If you have more questions, check out some of our other blogs for helpful information about business, marketing, and more.