1099 vs. W-2 Tax Forms: What You Need to Know

If you’ve been employed at any job, you’ve received a W-2 form. It’s a form most people are familiar with. If you’ve had investment income, worked as a freelancer or independent contractor, or won any prizes over $600, you’ve also received a 1099 form at some point.

In your new role as a business owner, you won’t receive W-2 forms anymore. Instead, you’ll receive 1099 forms from your clients, and you might even have to fill out W-2 or 1099 forms to report your employees’ or contractors’ wages.

In this guide, we’ll discuss the differences between employees and independent contractors, how they can benefit your business, and what tax form to use to report their incomes.

What is a 1099 and Who Needs One?

There are different 1099 forms but they all have one purpose, which is to report the various incomes that taxpayers receive. As a self-employed individual, freelancer, or independent contractor, you’ll most likely receive a Form 1099-NEC (Nonemployee Compensation) from your clients. This form records earnings that workers receive when they’re not considered employees.

Likewise, if you have freelancers, consultants, and independent contractors working for you, you’d have to fill out Form 1099-NEC for each of them. You’re required to report wages if you’ve paid anyone at least $600 for work they’ve done for your business, and you’ll need to send the forms out by Feb. 1.

Below are other Form 1099 examples you may receive:

Form 1099-INT: You’ll receive Form 1099-INT (Interest Income) from your bank or any financial institution where you earned at least $10 in interest.
Form 1099-G: If you received unemployment insurance within the year, state, local, or federal government tax refunds, or taxable grants, you’ll see these amounts on Form 1099-G (Certain Government Payments).
Form 1099-MISC: This form is used for any other income that doesn’t fit into the other 1099 forms. This includes health care insurance payments made on behalf of contractors, prizes and awards valued at $600, rent, and more.

What is a W-2 and Who Needs One?

The IRS Form W-2 (Wage and Tax Statement) is used to report an employee’s income from the previous year. The form also contains information like tax withholdings, contributions to retirement plans during the year, and employer-paid health insurance benefits. Employers are required to fill out a W-2 form for every employee who earned at least $600 during the year.

Whether you have part-time or full-time employees, you’re obligated to send each employee a copy of Form W-2 by the end of January. If you work online or remotely, you can send instructions on where or how they can access it.

1099 vs. W-2 Workers

Self-employed individuals working as independent contractors, freelancers, and consultants are sometimes called 1099 workers in reference to the tax form used to report their incomes. Independent contractors like yourself are regarded as business owners, which means you’re responsible for paying your income taxes and self-employment taxes. The self-employment tax rate is 15.3%, where 12.4% goes toward Social Security tax and 2.9% toward Medicare taxes.

As a 1099 worker, you’re generally hired and expected to work on a per-project or hourly basis. Unlike employees, you can define how and where you work. Since you assume the risk of making profits or losses when you accept a job, you can choose the tools and methods of how you will complete a project, which may include hiring your own employees or contractors.

On the other hand, employees (or W-2 workers) perform their duties according to their employer’s schedule and may be subject to company regulations and policies. Employees are guaranteed at least the minimum hourly rate and receive employee benefits, such as health insurance coverage, paid time off, and overtime pay. If you have employees, you’re required to withhold Social Security, Medicare taxes, and file payroll taxes for each person.

Whether you decide to get help from other independent contractors or employ your own workers, you must understand the difference between 1099 and W-2 workers for the following reasons:

You may incur penalties from the IRS for misclassifying an employee or an independent contractor.
You may be sued for employee misclassification.
Misclassification of an employee or an independent contractor could result in you needing to pay back taxes for deductibles you’ve claimed on your tax return from previous years.

The IRS offers the following guidelines to determine whether you have an employee or an independent contractor:

Behavioral: This is the degree of control you have over what the person does and how they do their job. If you dictate the hours of work and how the job is performed, you most likely are treating the person as an employee. If your agreement with a person only involves the specifications of a project and when it’s due without regard to how it’s done, you have an independent contractor.
Financial: This refers to whether you provide your workers’ tools and supplies or reimburse them for expenses incurred in carrying out their duties. Generally, independent contractors, such as freelance writers, provide their own computers and pay for their own internet connections. Meanwhile, you’d need to provide employees with the equipment and supplies they need to do their jobs.
Type of relationship: You can also determine if you have an employee or an independent contractor based on whether you have a written contract or if the worker is receiving any employee-type benefits from you, such as paid time off and overtime pay.

Pros and Cons of Employees and Contractors

As a small business owner focused on growing your business and generating profits, hiring and managing workers is going to be one of the major decisions you’ll need to make. Below is a list of the advantages and disadvantages of hiring regular employees or independent contractors to help you determine which suits your business needs best.

Pros of W-2 Employees

You have more control over your employees. You can expect your employees to show up on time for work, be subject to company policies, and deliver work according to your specifications and standards.
Employees may stay with your company for years. Employees who have years of experience with your company understand your business goals better and can contribute valuable insights for your growth.
Employees can develop a sense of commitment to your business, which can translate to a better work ethic and a healthy work environment.

Cons of W-2 Employees

Hiring and managing employees requires time and effort. You’ll have to schedule a time for interviewing and training. Even delegating tasks and checking their work will require time and energy.
You’re responsible for providing any tools and materials your employees need to do their jobs. Make sure you are aware of the resources you need to supply before you hire, such as equipment for a home office if they’re remote.
Aside from paying hourly rates or salaries, you’ll need to provide employee benefits like health insurance and paid leave. You’re also required to pay the employer’s share of Social Security and Medicare taxes. Consult with an accountant or a tax professional before you decide to take on an employee.

Pros of Independent Contractors

Independent contractors offer specialized expertise and flexibility, which are great if you need a specific skill for one or two specific projects. This kind of contract allows you to allocate your budget and resources efficiently.
Contracting freelancers can be more affordable because they pay their own taxes. You don’t have to file payroll taxes or provide employee benefits.
Managing independent contractors may require fewer business expenses and less paperwork and effort because you don’t have to account for hours worked, withhold income taxes, enroll on a workers’ compensation coverage, etc.

Cons of Independent Contractors

You have less control over independent contractors. It’s highly recommended that you draft a contract between you and a freelancer for your mutual benefit. Define the scope of work, payment terms, and pay rates, among other things.
You’re not required to provide health benefits or workers’ compensation to your contractors, but a worker could hold you accountable if he or she gets injured on the job. Make sure you have the necessary insurance and protection before hiring contractors.

More Resources for Getting Your Business Started

Whether you need to hire an employee or engage the services of an independent contractor depends largely on your business’s bottom line. If you need specialized skills for a limited amount of time, you may be better off with a contractor. If you need continuous help for specific tasks, you might want to hire an employee.

As you juggle the myriad duties of starting your business and building your team, let our dedicated team handle the legal details for you. At ZenBusiness, we strive to make business formation affordable and easy. We also offer great resources to help business owners like you move your businesses forward.