There are two main categories of work in the eyes of the IRS — 1099 contractors and W-2 employees. These two types of work involve different tax forms and come with different tax obligations for employers and workers.
Generally speaking, W-2 employees have taxes withheld from their paychecks by their employer, while 1099 contractors are responsible for paying taxes on their own
The difference between 1099 work and W-2 work also depends on the nature of the employment relationship — and there are strict rules about which kinds of workers can be given each classification. Here’s what to know.
1099 workers get that name from the
1099-NEC tax form
they receive from their employer(s) each January or February.
The form lists the amount of nonemployee compensation they received from a particular employer. 1099 forms typically show the gross amount paid in the previous year since the employer does not withhold tax unless the worker is subject to backup withholding.
The employer (or “payer,” in tax jargon) sends the 1099 form to the IRS and also provides workers with a copy to help them determine their total income (and income tax liability) when filing their annual income tax return.
W-2 employees are so named because their employers send them a
W-2 form
at the beginning of each year, listing their compensation from the previous year and the amount of income tax withheld.
Employees who earned $600 or more in the previous year get one and use it to complete their tax returns. A W-2 form also contains additional information that isn’t applicable to a 1099 worker, including pre-tax payroll deductions such as
401(k)
contributions and employer-sponsored health insurance plan costs.
Like 1099 forms, employers send a copy of a W-2 form to both the IRS and the employee.
1099 contractors vs. W-2 employees
The IRS provides rules for classifying 1099 vs. W-2 work. The guidelines are divided into three categories: behavioral, financial and type of relationship.
-
Behavioral.
Typically, W-2 employers have the right to control how, where and when a worker does their job — for example, by mandating certain working hours, making a worker come into an office or providing specific tools for the job. 1099 employers don’t have this kind of control, and can only set deliverables and deadlines.
-
Financial.
W-2 employment generally means work for a regular paycheck (subject to
minimum wage
and overtime laws), while 1099 work can involve one-off or irregular payments at any pay rate. W-2 employees are also often reimbursed for work-related expenses, while 1099 workers are usually responsible for their own expenses.
-
Type of relationship.
W-2 employment may come with benefits and often has an indefinite timeframe. 1099 work, on the other hand, generally doesn’t come with benefits and may be limited to a specific timeframe or the completion of a specific project.
If a business is having trouble determining whether a worker should be classified as 1099 or W-2, it can submit
Form SS-8
to the IRS and let the agency decide
.
Examples of W-2 employees
As discussed previously, W-2 workers are typically people who have to show up to a workplace and/or have set working hours.
They typically receive a regular paycheck with income tax withheld and may also get benefits. Some jobs that are typically classified as W-2 include office and factory workers, waiters, cooks, retail associates, healthcare workers, government employees, and maintenance workers.
On the other hand, 1099 contractors generally set their own hours and work conditions and may be paid on a one-time or sporadic basis. They do not receive benefits or have income tax withheld. Examples of 1099 contractors include freelance writers, graphic designers, sole-proprietor tradespeople, and gig-economy workers.
There are significant tax implications for both workers and businesses when it comes to 1099 work versus W-2 employment. 1099 workers are responsible for paying their own taxes, including estimated taxes and self-employment tax, while W-2 workers have taxes withheld by their employer.
Businesses also have different tax responsibilities for 1099 contractors compared to W-2 employees. They must withhold taxes for W-2 employees and pay certain taxes on their behalf, while they do not have to withhold taxes for 1099 contractors unless subject to backup withholding. Businesses must collect a W-9 from 1099 contractors and file a 1099 form each year.
It is important for businesses to correctly classify workers as either W-2 employees or 1099 contractors to avoid misclassification and potential legal and financial consequences. Misclassifying W-2 employees as 1099 contractors can save businesses money and time in the short term, but can lead to penalties and back taxes if discovered by tax authorities.
Employers may also be enticed to do this in order to avoid complying with minimum wage and overtime laws for their employees.
Misclassifying employees can have serious legal repercussions, such as fines, penalties, repayment of uncollected employment taxes, and in extreme cases, imprisonment.
If employees suspect that they are being misclassified, they can make a confidential complaint to the Department of Labor. They can also file Form SS-8 with the IRS to resolve any uncertainty regarding their classification as either 1099 or W-2.
In certain situations, employers who had a “reasonable basis” for misclassifying employees, or those looking to reclassify workers with ambiguous status as W-2 employees to prevent future legal issues, may reach a settlement with the IRS. This agreement can bring them into compliance with the law while offering some relief from tax penalties. Refer to the IRS resources on employment tax relief and the Voluntary Classification Settlement Program (VCSP) for more information.
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