Form W-2 vs Form 1099 – Understanding the Differences

December 18, 2023 by Gordon Middleton

In addition to submitting annual wage reports to workers and filing these reports with the Internal Revenue Service (IRS) or the Social Security Administration (SSA), employers need to determine whether someone who works for their company is an employee or an independent contractor and provide them with correct forms. Thus, it is important to understand the differences when it comes to Form W-2 vs Form 1099 and make sure to maintain compliance during year-end processing.

Overview of Form W-2 vs Form 1099

Form W-2 and Form 1099 are both information statements, but they have different purposes and represent different types of workers. To begin with, employers need to classify their workers as either employees or independent contractors. Also, a proper understanding of the differences between Form W-2 vs Form 1099 helps them reduce the chances of tax errors and potential fines.

Form 1099

Form 1099 is a tax information return that reports income received outside of wages, salaries and tips. There are three different versions, each with different purposes:

  • Form 1099-NEC reports how much a business paid annually to nonemployees, including independent contractors;
  • Form 1099-MISC reports a business’s miscellaneous payments; and
  • Form 1099-K reports payment card transactions through third-party networks.

Form 1099 reports the income a business pays to taxpayers who are not full-time employees. Any employer who pays an independent contractor, freelancer, self-employed person or sole proprietor for services they provided must file Form 1099 with the IRS for each of them. At the same time, a nonemployee contractor who receives Form 1099 from an employer must report that income on their tax return.

Businesses issue Form 1099 for every nonemployee paid more than $600 in the calendar year, but it can be filed even if payments are less.

Individuals or businesses can receive Form 1099 for payments including some of the following:

  • Services performed by someone other than an employee;
  • Other income payments;
  • Rent payments;
  • Prizes and awards;
  • Medical and healthcare payments;
  • Payments to attorneys with exceptions; or
  • Payments to a business like a limited liability company (LLC), sole proprietorship, or partnership.

However, corporations and S corporations, usually do not receive Form 1099.

Form W-2

Form W-2, also known as the Wage and Tax Statement, discloses taxable income for the year and is generally provided for full-time employees of a company. This information is distributed to each person in advance of the annual federal tax filing deadline.

Federal law requires all employers to send Form W-2 to employees no matter how low earnings or wages are. Failure to do so in a timely manner can result in significant fines for businesses. Also, employers must send Form W-2 on or before January 31 each year, so that employees have enough time to file their taxes before the deadline which is April 15 in most years.

Employers need to prepare six copies of every Form W-2 issued to an employee. The first copy, Copy A, is sent to the SSA. The second copy, Copy 1, is sent to either a state, city or local tax department. And finally, the third copy, Copy D, is kept by the employer for their records. Employers also need to furnish Copies B, C, and 2 of Form W-2 to employees.

Form W-2 can be sent in either paper or digital form. Employers are legally required to keep these forms on file for at least four years and to complete an employment identification number (EIN) form. They also need to keep in mind that they are ultimately responsible for making sure Forms W-2 for all employees are mailed and filed by the IRS deadlines.

Form W-2 vs Form 1099

When it comes to differences between Form W-2 vs Form 1099, it is important to note that the latter form is used for payments to independent contractors and no tax payments are reported. On the other hand, Form W-2 outlines not only taxable compensation to employees but also federal and, if required, Federal Insurance Contributions Act (FICA) and state income tax withholding. In addition to this, Form W-2 is used to report salary reduction amounts for contributions to 401(k) plans, certain employee benefit plans, other withholding, and various employee benefits.

There are situations when the same employee can receive both Form W-2 and Form 1099. This may happen if a nonemployee who provides services to the company is hired during the year to be an employee. However, businesses should be extremely careful when it comes to changing worker classification and using Form W-2 vs Form 1099.

Reducing Costs with Proper Worker Classification

Proper worker classification is essential for every business given that misclassifying an employee as a nonemployee can result in increased tax bills and penalties for not paying the appropriate employment taxes and for using the wrong form. Businesses may also be subject to penalties for failing to take appropriate state withholding and deductions, and not making contributions to state disability and unemployment agencies.

To help employers prevent worker misclassification, the IRS offers guiding questions that can help clarify the nature of the worker’s engagement with the paying company. These questions revolve around the degree of control the company has and the level of independence of the worker and include three general criteria: behavioral control, financial control, and the relationship between the worker and employer.

To avoid worker misclassification and determine whether to use Form W-2 vs Form 1099, the IRS recommends evaluation of the entire relationship, consideration of the degree or extent of the right to direct and control work, and also documenting each of the factors used to make the determination.

In addition to this, employers can consider outsourcing payroll tax management and optimizing tax form processing. This ensures proper handling of workers and payments compliant with IRS rules and puts an end to any tax errors and the resulting penalties.

Handle increasingly complex payroll tax requirements by automating tax management and ensuring compliance with ever-changing tax laws and regulations.

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