1099 vs. W-2 Tax Forms: When Do Employers Use Them and Why?

Protect your business by filing forms W-2 and 1099 correctly. Use these forms to report payments to contractors and payroll tax withholdings from employees.

Businesses are required, through the filing of information returns, to tell the Internal Revenue Service (IRS) about payments they made for work performed. The type of information return used for this purpose depends on the nature of the service provider — as an employee or independent contractor. The party required to file the information return is the business for which the work is performed. These forms enable the IRS to be sure that service providers are properly reporting employee income and that the business is paying employment taxes for service providers who are employees.

What's the Difference Between 1099 and W-2 Forms?

The main difference between the 1099 and W-2 is primarily what's entered on it:

• The 1099 is solely for payments to independent contractors. No tax payments are reported on this form.
• The W-2 is a more comprehensive information return, listing not only taxable compensation to employees, but also federal (and where required, state) income tax and Federal Insurance Contributions Act (FICA) withholding, salary reduction amounts for contributions to 401(k) plans and certain other employee benefit plans, and other withholding (e.g., for state disability benefits in certain states, or paid family and medical leave benefits in certain states) including various employee benefits (e.g., health coverage, group term life insurance, and dependent care assistance).

Wages and other payments to employees are reported on Form W-2, while payments to independent contractors are reported on a Form 1099. Each business must classify its workers as either employees or independent contractors to file the appropriate form.

From an employer's perspective, it can be less costly to use independent contractors than employees. The savings come from not having to pay employment taxes for independent contractors and provide them with benefits; there's also savings in administrative costs. However, worker classification is not simply a matter of choice. For federal tax purposes, a worker is an employee and can't be treated as an independent contractor if the company exercises sufficient control over when, where, and how the work is done. More specifically, the IRS has certain tests — behavioral, financial, and relational — that are used to decide when a worker is an employee for taxation purposes.

In contrast, independent contractors are essentially workers in business for themselves. They generally control when and how their work is accomplished, use their own tools and equipment, and risk profit or loss on each assignment.

Businesses should keep in mind that the IRS test is focused on whether an individual is an employee or an independent contractor for federal tax purposes. There are other tests used to evaluate if an individual is correctly classified as an independent contractor under federal, state, or local employment laws and regulations. This includes determining the appropriate classification for wage and hour, unemployment insurance, and workers' compensation purposes.

What Is a 1099 Tax Form?

A 1099 form is an annual information return listing the gross amount of payments made to an independent contractor. It's required to be filed by the business for whom services were performed if payments to an independent contractor during the calendar year total $600 or more. It can be filed even if payments are less.

There are two types of 1099 forms that impact employers the most: a 1099-MISC and a 1099-NEC. If you're wondering when to use a 1099-NEC vs. MISC, here's where the two forms differ:

• As of tax year 2020, IRS Form 1099-NEC is the independent contractor tax form used by businesses to report payments to a contract worker in the previous tax year. It's filed with the IRS and also provided to the contractor for reporting income.
• Form 1099-MISC was previously used for independent contractor payments, but it's now used to pay royalties, rent, or payments classified as other income.

What Is a 1099 Worker?

A 1099 worker is often referred to as an independent contractor, a designation for a type of worker who contracts their services to a business. As we'll discuss later on, businesses need to take particular care to correctly classify their workers. So, while it's best practice to consult an HR advisor or legal counsel to ensure proper classification, some examples of types of workers who would receive a 1099 form may include:

• A consultant who is brought in for a set amount of time to complete a project.
• A freelance web developer who works on a per-assignment basis and uses their own computer.
• An electrician contracted three times throughout the year to repair power outages in an office building.

When To Issue a 1099

You would issue a 1099 form to individuals or other businesses that provided some kind of service, but aren't employees of your business. Independent contractors may be used in situations where there is a project or assignment with set start and end times, there's no guarantee that you'll have continuous and ongoing work for them to do, there are no set hours, or the work can be done without supervision or oversight.

When Should 1099s Be Sent Out?

Per IRS guidelines, employers are required to issue a 1099 to independent contractors who earned more than $600 in non-employment compensation in a year by January 31 of the following year. Form 1099-NEC is sent to the worker or business that performed services, as well as to the IRS.

What Is a W-2 Tax Form?

Form W-2 is an annual information return provided to an employee listing taxable wages as well as income tax withholding and withholding of Social Security and Medicare taxes. The form also lists various employee benefits (some taxable, some tax-free) as well as state income tax withholding. It must be filed by the employer for each employee, regardless of the amount of compensation paid during the year.

What Is a W-2 Employee?

In terms of taxes, a W-2 employee is an individual who is paid through their employer's payroll and has their payroll taxes withheld throughout the year. By January 31, the W-2 employee receives a Form W-2 that includes information around taxable compensation, tax withholdings, and any additional tax deductions for employee benefits such as employer-sponsored health coverage or 401(k) plans. The W-2 employee then uses this information to complete their yearly taxes. Some examples of employees who would receive a Form W-2 may include:

• An office worker with scheduled hours, ongoing work, a company-issued laptop, and a direct supervisor.
• A warehouse supervisor who has scheduled hours each week and receives periodic training.
• An administrative assistant who is required to be in the office from 9am-5pm, has set responsibilities, and receives health insurance through an employer-sponsored medical plan.

When To Issue a W-2 Form

You must issue a Form W-2 to every employee who you paid during the year and withheld certain taxes from their paychecks. Determining whether you have an employee vs. independent contractor is based on the manner and circumstances in which you work with these individuals, which is part of the IRS tests mentioned above. Generally, having W-2 employees means that individuals have been given ongoing work, they use equipment that the company has provided for them to do their work, they have set hours, and there is oversight from a direct manager or supervisor.

When Should W-2s Be Sent Out?

Per IRS guidelines, employers are required to issue a Form W-2 to every employee who worked for them in a year by January 31 of the following year. This is also the date when copies of W-2s must be sent to the Social Security Administration (SSA).

Can an Individual Get Both a W-2 and a 1099?

In some situations, the same person can receive both a 1099 and a W-2. For example, if an individual who is an officer and employee of a corporation also serves on the board of directors, this person may receive a W-2 for employee compensation as well as a 1099 for fees received as a corporate director (a non-employee position).

Another way in which the same person can receive both types of information returns from the same company for the same year is where an independent contractor who provides services to the company is hired during the year to be an employee. This worker receives a 1099 for payments during the time of being an independent contractor, and a W-2 for payments once the person is put on the payroll. But businesses should be careful about changing worker classification from employee to independent contractor or vice versa, particularly if the person continues to perform the same work in the new status.

Filing 1099 vs. W-2 Forms

Companies' responsibilities for filing 1099s and W-2s are twofold: providing originals to the workers and transmitting copies to the government. Be sure to follow rules for furnishing workers with their forms. For example, an employer can send an employee their W-2 electronically instead of mailing or handing it to the employee, provided there is prior consent to this (consent should be electronic to ensure that the employee has a way to access the W-2 when it's sent).

W-2s must be transmitted to the SSA electronically if the company has 250 or more W-2s. But a smaller employer may choose to do so to save time and ensure accuracy. The copies must be accompanied by Form W-3. If electronic filing is not used, then copies with a transmittal form must be mailed to the SSA.

For 1099s, these forms can be sent electronically to independent contractors as long as they've given prior consent to receive their form in this manner. 1099s must be transmitted to the IRS electronically if the company has 250 or more 1099s. Electronic filing is done through the Filing Information Returns Electronically (FIRE) system (employers must register to do this if they plan to file themselves).

There are current proposed regulations that would lower the electronic filing threshold for all information returns, but they are not finalized. Until they are finalized, the 250 threshold remains in place.

Why Is It Important for Employers To Correctly Classify Workers to the IRS?

It's essential that small businesses correctly classify their workers under the IRS test, and other tests used to evaluate whether an individual is correctly classified as an independent contractor under federal, state, and local employment laws and regulations. Misclassifying an employee as an independent contractor can result not only in having to pay back wages, employment taxes and serious penalties, but also possibly unpaid employee benefits (e.g., health coverage, retirement plan contributions).

IRS penalties for unpaid employment taxes due to worker misclassification can mount up. Typically, the IRS will go back for three years of unpaid taxes.

• Penalty for not filing a required Form W-2 in 2023: $50 per form if filed within 30 days after the due date; $110 per form after more than 30 days but not after August 1; $290 per form if filed after August 1. These penalty amounts can be adjusted annually for inflation.
• Penalty for failure to withhold wages: 1.5 percent of wages, plus interest.
• Employee's share of FICA: 40 percent.
• Employer's share of FICA: 100 percent.
• Failure to pay tax: 0.5 percent of the unpaid tax liability for each month (up to 25 percent of total tax liability).

If the IRS thinks that misclassification was fraudulent or intentional to avoid paying employment taxes, penalties can include 20 percent of wages paid plus all of FICA (100 percent of the employee and employer share). Owners can be held personally liable for income taxes and the employee share of FICA that should have been withheld.

And the IRS may even seek criminal penalties of up to $1,000 per misclassified worker. What's more, the U.S. Department of Labor can impose its own penalties for worker misclassification.

Section 530 relief may help you avoid employment tax penalties. This allows businesses to avoid employment tax penalties resulting from worker misclassification as long as they've reported payments to contractors on 1099s, consistently reported workers, and have a reasonable basis for treating them as independent contractors. There's also a way to minimize penalties by voluntarily reclassifying contractors as employees under the IRS' Voluntary Classification Settlement Program (VCSP).

What Are the Important Deadlines for Filing W-2s and 1099s?

Both Forms W-2 and 1099 must be furnished to the service provider by January 31 of the year following the year of payment (e.g., January 31, 2023 for wages/compensation paid in 2022).

The same filing deadline applies to submissions of the forms to the government, whether done electronically or on paper. January 31 is the deadline for submitting copies of the forms, along with a transmittal form to:

• The IRS for 1099s reporting non-employee compensation (along with Form 1096).
• The Social Security Administration for W-2s (along with Form W-3).

The deadline is strictly enforced. If a business can't meet the deadline, it can request a 30-day extension through Form 8809, but it's not granted automatically. There are five acceptable reasons for which the IRS will grant a non-automatic filing extension:

1. The business experienced a catastrophic event in a federally declared disaster area.
2. The business suffered a fire, casualty, or natural disaster affecting the operation of the business.
3. There was a death, serious illness, or unavoidable absence of the person responsible for filing the returns.
4. The information return is being filed for the first year the business is established.
5. The filer didn't receive timely data on a third-party statement that was needed for completing the form.

And there's no possibility of any additional extension of time to file. Penalties will begin to accrue after the extension period ends.

Taxing W-2 Employees and 1099 Workers Correctly Protects Your Business

Correctly classifying your workers by putting them on the payroll where appropriate and submitting the right information return to report payments to them can both go a long way in protecting your business from trouble with the IRS. A reputable payroll services provider can help your business handle its workers and payments to them in compliance with IRS rules.

Additional FAQs

Is a 1099 a W-2?

A W-2 is a separate form from a 1099, the primary difference being that the W-2 is issued to employees on the company payroll, whereas a 1099 is given to independent contractors and other non-payroll workers.

Can You File W-2 and 1099 Separately?

For individuals who have W-2 income as an employee and earnings as a 1099 worker, they would generally report all of this information together on their personal tax returns. For businesses issuing both W-2s to employees and 1099s to independent contractors, you will want to file them and send copies to the appropriate government agencies separately.

What Is the Tax Rate for 1099 vs. W-2?

In situations where you have employees and issue W-2s to them, you as the employer pay half of Social Security and Medicare (FICA) taxes, equaling 7.65 percent, and withhold the other half from employee paychecks each pay period. Independent contractors who receive 1099s pay the full 15.3 percent self-employment tax from their earnings.

Why Is It Necessary To Have a W-2 or 1099?

Both W-2s and 1099s are necessary because the information on these forms is used to report important data about earnings to the appropriate government agencies. For an employee, they need a W-2 to accurately file federal and state taxes. For an independent contractor, information on a 1099 helps them report income to the IRS and determine appropriate tax liability.