W-2s and 1099s are much more than tax forms. They represent two types of professionals—a traditional full-time employee and a self-employed contractor. These tax classifications also carry distinct financial and legal implications, so it’s important to recognize the nuances of each classification before building a hiring plan, especially if you’re actively hiring.
This post will clarify the differences between W-2s and 1099s, help you understand the legal and tax consequences of each classification, and explain the steps involved in paying each one.
What’s a W-2 employee?
A W-2 employee is named after a form issued by the IRS to report wages and taxes paid to an employee of a company. A recent survey found that 92% of US tax filers received W-2 income as employees.
According to the IRS, every employer “engaged in a trade or business who pays remuneration, including noncash payments of $600 or more for the year” (essentially any company that pays for their employees’ services) must file a W-2 form.
W-2 employees are typically subject to the direction and control of the employer in the performance of their work, and their employer withholds federal income tax, Social Security tax, and Medicare tax from their paychecks. The employer is also responsible for paying a matching amount for the Social Security and Medicare taxes.
W-2 employees may be entitled to benefits like healthcare and retirement plans, and their employer must comply with various employment laws and regulations that apply to employees, including minimum wage laws, overtime laws, anti-discrimination laws, and workers' compensation laws.
HRIS (Human Resources Information System) providers like Rippling can help employers streamline employee benefits management and ensure you stay compliant with federal and state regulations.
How do I pay a W-2 employee?
Step 1: Obtain a completed W-4 form from the employee, which includes information on their withholding allowances.
Step 2: Based on the information from the W-4, calculate the amount of federal income tax to withhold from the employee's paycheck. You are also responsible for withholding and paying Social Security and Medicare taxes, which are calculated as a percentage of the employee's wages. These taxes are split between the employer and the employee, with the employer paying a matching amount to the employee's contribution.
Step 3: You must provide the employee with a W-2 form by January 31 of the following year, which summarizes their total wages and tax withholding for the previous year. The employee uses this form to file their personal income tax return.
Rippling makes onboarding and payment processing ridiculously simple—it has everything you need to run a global workforce from a single system. All the compliance work, including the nuances of W-2 forms, is built in, so you can pay all of your employees—whether they are classified as W-2 or 1099—in just 90 seconds.
3 advantages of hiring W-2 employees
- Consistency and culture: A W-2 employee is a permanent employee, which means they are available for work consistently. Because of this consistency, a company with W-2 employees will have a stable workforce. Consistency and stability can also be major contributors to establishing a positive and enduring company culture.
- Greater control: Businesses have more control over the work and productivity of W-2 employees than independent contractors, with the legal ability to manage their work in accordance with company policies.
- Benefits and protections: As an employer, you are required to offer certain benefits to W-2 employees. These benefits can help you attract and retain top talent while providing a sense of security for employees.
3 disadvantages of hiring W-2 employees
- Higher costs: Hiring W-2 employees can be more expensive than hiring independent contractors or freelancers. You must offer certain benefits and pay taxes on their behalf. You may also have to pay for equipment, training, and other perks.
- Legal obligations: As an employer, you are required to comply with federal and state employment laws, such as minimum wage requirements, overtime pay, and anti-discrimination laws. It can be complex and time-consuming to stay on top of all the relevant regulations and ensure you stay compliant at all times (hint: Rippling helps ensure you stay compliant, automatically).
- Limited flexibility: W-2 employees may not offer the same flexibility as independent contractors, who can work on a project-by-project basis. It’s also difficult to reduce headcount without incurring significant costs or negative impacts on morale.
What’s a 1099 contractor?
A 1099 is a form issued by the IRS used to report payments made to an independent contractor or self-employed individual. Unlike W-2 employees, 1099 contractors are considered to be self-employed and are responsible for paying their own taxes, like federal income tax and self-employment tax. They are also responsible for finding, registering for, and paying for their own benefits, including health insurance and retirement plans.
1099 contractors are typically hired for a specific project or task. Their contracts dictate the business’s level of direction and control over their work. In some cases, contracts may require a 1099 contractor to work onsite, whereas others may permit them to work wherever they like. Typically, however, an independent contractor is not subject to the level of managerial control a W-2 employee may encounter.
How do I pay a 1099 contractor?
Step 1: Obtain a completed W-9 form from the contractor, which includes their taxpayer identification number and other relevant information. This is used to report payments made to the contractor to the IRS.
Note that you are not responsible for withholding federal income tax from the contractor's payments. Instead, the contractor is responsible for making estimated tax payments throughout the year based on their income. You are also not responsible for withholding or paying Social Security and Medicare taxes for the contractor.
Step 2: You must provide the contractor with a 1099 form by January 31 of the following year, which summarizes the payments made to them during the previous year. The contractor uses this form to file their personal income tax return.
3 advantages of hiring 1099 contractors
- Cost savings: Hiring 1099 employees can be cost-effective as they are responsible for paying their own taxes, insurance, and benefits.
- Flexibility: 1099 employees can offer your businesses more flexibility, as they can work on a project-by-project basis or as needed.
- Specialized skills: 1099 employees may have specialized skills and expertise that are either unavailable in-house or too inconvenient to hire, onboard, and train a new W-2 employee to utilize.
3 disadvantages of hiring 1099 contractors
- Limited control: Businesses may have limited control over 1099 contractors’ work as they are not considered employees and work independently.
- Legal obligations: Businesses must ensure that 1099 contractors are properly classified as independent contractors, and not misclassified as W-2 employees. Misclassifying employees can result in legal and financial consequences (noted below).
- Dependability: 1099 employees may not be available to work when needed, as they may have other clients or commitments.
How to classify employees vs contractors
In general, W-2 employees are considered traditional employees who work on a regular basis and are subject to the employer's control, whereas those receiving a 1099 are considered independent contractors who work on a project-by-project basis and have more control over how they perform their work.
You should consider classifying an employee as an independent contractor if they:
- Provide their own equipment or tools for the job
- Are paid on a per-project or commission basis
- Have other clients or customers in addition to your business
- Have a high degree of control over how they perform their work
Ultimately, employee classifications should be based on a careful analysis of the individual relationship with the employee or contractor, as well as the specific details of their employment arrangement.
Tax implications for W-2 employees and 1099 contractors
Subject to federal income tax, Social Security tax, and Medicare tax, all of which are withheld from their paycheck by the employer. The employer is also responsible for paying a matching amount for the Social Security and Medicare taxes.
1099 contractors are responsible for paying their own federal income tax, as well as self-employment tax, which includes both the employer and employee portions of Social Security and Medicare taxes. They may also be responsible for paying state and local taxes, depending on their location.
While employers are responsible for paying state and local payroll taxes, depending on the state and company size, they may not be legally obligated to provide benefits like healthcare and retirement plans.
1099 contractors are not entitled to benefits such as healthcare and retirement plans.
W-2 employees receive a W-2 form from their employer, which summarizes their total wages and tax withholding for the previous year. They use this form to file their personal income tax return, which is due on April 15 of the following year.
1099 contractors receive a 1099 form from each client who paid them more than $600 during the year. They use these forms to report their income on their personal income tax return, which is due on April 15 of the following year.
Legal implications of employee and contractor classification
Misclassifying employees or contractors—whether intentional or not—can have significant legal consequences for both the employer and the employee or contractor.
Employers must comply with various employment laws and regulations that apply to employees, including minimum wage laws, overtime laws, anti-discrimination laws, and workers' compensation laws. If an employer misclassifies an employee as a contractor, the employer may be liable for back wages, taxes, and penalties.
Contractors, on the other hand, are generally not entitled to the same legal protections as employees. They are not covered by minimum wage laws, overtime laws, or anti-discrimination laws. They are also not eligible for workers' compensation benefits if they are injured on the job.
If only the IRS were this simple
Welcome to the part where we tell you that Rippling can help you onboard employees and contractors in 90 seconds. Rippling can also help you take care of those compliance obligations we mentioned above—automatically.
It’s our mission to simplify HR, IT, and finance—all the mechanics of running a business of 2 or 20,000. Here’s how we do it:
- Effortless onboarding: Whether you're hiring a new employee or contractor, Rippling makes it easy to get them up and running quickly.
- Payroll processing with a few clicks: Rippling handles all payroll processing, including tax withholding and reporting for W-2 employees and 1099 contractors.
- Time and attendance tracking: Rippling offers time-tracking tools that work for both hourly employees and contractors.
- Transparent and compliant benefit administration: Rippling makes it easy to manage benefits for W-2 employees, from health insurance to retirement plans.
- Simple contractor payments: Rippling provides a streamlined process for paying 1099 contractors, including direct deposit and online payment options.
- Automated compliance management: Rippling helps you stay compliant with employment laws and regulations, from minimum wage laws to workers' compensation requirements.
By using Rippling, you can ensure that both your full-time employees and contractors—all those W-2s and 1099s—are paid accurately and on time, and that you're staying compliant with all relevant laws and regulations.
Ready to see Rippling in action? Let’s get to work.
Disclaimer: Rippling and its affiliates do not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advise. You should consult your own tax, legal and accounting advisors before engaging in any related activities or transactions.