W-2 Vs. Form 1099

Different types of income are reported on W-2 and 1099 forms.

A W-2 form and a 1099 form are two widely used federal income tax forms that companies use to report taxable income paid to individuals. An employer sends W-2 forms to its employees who earned wages during the year. Payments made to independent contractors are reported on the 1099 form.

Classification

Employees receive W-2s; independent contractors receive 1099s.

A W-2 form is used by an employer to report wages paid to an employee. The IRS has a number of tests that determine whether a worker is an employee or independent contractor. One such test is that an employee has no autonomy in the way he carries out his job, what job he does or where the work is performed. Conversely, an independent contractor is self-employed and can perform the assigned work at the time and place of his choosing. An independent contractor may work for a number of different companies throughout the year.

Withholding

With Form 1099, it's up to the independent contractor to be ready for April 15.

Both W-2 and 1099 forms are used for reporting money paid to individuals. If a W-2 is used, the employer deducts withholding for personal income tax, Social Security and Medicare, as well as state and local taxes. Conversely, a self-employed person is paid the full amount for a job performed and no taxes are withheld. The full payment is reported on Form 1099 and the self-employed individual is responsible for paying all of the taxes owed on the income.

Common Misconceptions

The IRS uses three primary criteria to decide employment status.

Employers frequently confuse the terms "employee" and "independent contractor." They assume that they can choose how they classify a person who does work for them. According to the IRS, three criteria must be weighed which involve behavioral, financial and ongoing relationship considerations. Companies will be held liable for back payroll taxes and penalties if they incorrectly classify an employee as an independent contractor.

Filing Taxes

If you are self-employed, you pay estimated quarterly taxes to avoid a large bill at tax time.

Based on an IRS formula, taxes are withheld from a W-2 employee's paycheck throughout the year and deposited with the federal government. Independent contractors are paid the full amount promised for a particular job and no taxes are withheld; the income is reported on a 1099 and it is up to the self-employed individual to pay all taxes owed on the income. Independent contractors who expect to earn significant income must prepay estimated quarterly taxes during the year.

Considerations

Probably the most important distinction between W-2s and 1099s is that an employer must pay payroll taxes on a W-2 employee. These taxes include matching amounts of Social Security and Medicare tax, unemployment tax, and possibly other state and local taxes. Payroll taxes can be substantial, adding up to 10 percent or more of the worker's gross wages. For this reason, employers may try to classify workers as independent contractors when, in fact, the IRS would treat them as employees. If the IRS determines that a worker has been misclassified and payroll taxes should have been withheld, the employer will be liable for those back taxes as well as penalties. The IRS is very aggressive about enforcing this law.

References

• IRS: Independent Contractor (Self-Employed) or Employee?

Resources

• IRS: Small Business and Self-Employed Tax Center