The answer to this question essentially boils down to whether someone who does work for you is self-employed or an employee. Here’s the difference:
- Self-employed independent contractors are paid in full for their services and are responsible for settling up with federal and state governments at tax time. The payor reports payments on IRS Form 1099-NEC—assuming contractors earned more than $600 from them, their business entity is not an S corp or C corp, and they were not paid via credit card or third party settlement platform (like PayPal). Be sure to have your contractor fill out a W-9 on their first day of work so you know if and how you need to fill out their 1099-NEC come tax time
- Employees, on the other hand, typically have federal and state income tax, Social Security and Medicare payments withheld from their paychecks throughout the year (these withholding amounts are based on the elections they make on their IRS Form W-4). Employers issue them IRS Form W-2 to show them how much they were paid, as well as how much of their pay was withheld to pay income taxes, Social Security and Medicare.
Employers are also required to send copies of1099-NECs to the IRS and W-2s to the IRS and Social Security Administration so if a contractor or employee fails to report any income on their tax returns, the IRS will kindly let them know. Depending on where you are located, your state may also require state copies of 1099s and W-2s that you issued.
Are there different types of 1099s or W-2s?
For the most part, Form 1099-NEC and Form W-2 are the standard forms used for these two types of worker. There are a handful of variations on each that are used in special circumstances, such as those involving earnings from qualified tuition programs or wages paid by American Samoa employers. Form 1099-MISC is another variety of 1099 that many business owners need to report other business costs, such as medical and healthcare expenses and payments to attorneys. You should also use the 1099-MISC to report direct sales of consumer products that amount to $5,000 or more, depending on whom you sell to and where they will resell your products.The IRS has posted downloadable instructions for all available 1099-related forms here and all available W-2-related forms here.
There are a number of details and fine print to keep track of when it comes to tax forms. Here’s the take-way: document everything and let your CPA know about all of your expenses and sales to be sure that you’re reporting everything correctly. It’s a good idea to be familiar with 1099s, W-2s, W-9,s and W-4s—and you’re off to a good start!
What if I run a business and I’m not sure whether someone is technically a contractor or an employee?
Check out this article for an in-depth explanation of the two. As an overview, the IRS has identified three categories of evidence designed to help you figure it out:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (e.g., pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
If you’re still not sure, you can file a Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) with the IRS. The IRS will review the facts and determine the worker’s status for you. The process can take up to six months. For general information on the difference between independent contractor and employee, consult the IRS guidelines here.
Beyond that, if you ever find yourself at a loss as to which tax form goes to who, just refer to these two handy equations: self-employed = 1099; employee = W-2.
This post was originally published on March 21, 2018.