1099 vs. W-2: When Do Employers Use These Tax Forms & Why?
Businesses are required, through the filing of information returns, to tell the 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 whom the work is performed. These forms enable the IRS to be sure that service providers are properly reporting their income and that the business is paying employment taxes for service providers who are employees.
Understanding 1099 and W-2 forms
Wages and other payments to employees are reported on Form W-2, while payments to independent contractors are reported on a Form 1099. (For 2019, use Form 1099-MISC; for 2020 and later, use Form 1099-NEC.) Each business must classify its workers as either employees or independent contractors to file the appropriate form.
From an employer's perspective, it is usually much 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 a savings in administrative costs. However, worker classification is not simply a matter of choice. 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.
In contrast, independent contractors are essentially workers in business for themselves. They control when and how their work is accomplished, using their own tools and equipment, and risking profit or loss on each assignment.
What is a 1099 tax form and when do you need it?
Form 1099-MISC or 1099-NEC is an annual information return listing the gross amount of payments made to an independent contractor. It is 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.
- For 2019, use Form 1099-MISC and enter payments to an independent contractor in box 7 for non-employee compensation.
- For 2020, use Form 1099-NEC and enter payments to an independent contractor in box 1 for non-employee compensation.
What is a W-2 and when do you use this form?
Form W-2 is an annual information return provided to an employee listing taxable wages as well as income tax withholding and payments 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 the difference between a 1099 and a W-2?
The main difference between the 1099 and W-2 is merely what's entered on it. The 1099 is solely for payments to independent contractors; no tax payments are reported. 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) and various employee benefits (e.g., health coverage, group term life insurance, and dependent care assistance).
Can an employer give a 1099 and W-2 to the same person?
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 has been put on the payroll. But businesses should be careful about changing worker classification from an employee to an independent contractor, particularly if the person continues to perform the same work in the new status.
Filing 1099 and 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). And 1099s can be sent electronically to independent contractors as long as they've given prior consent to receive their form in this manner.
Copies of W-2s must be transmitted to the Social Security Administration (SSA) electronically if the company is required to file 250 or more W-2s for 2019 in 2020. But a smaller employer may choose to do so to save time and ensure accuracy. Note that the e-filing threshold is reduced to 100 forms in 2021 and to 10 in 2022. 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.
Similarly, if a business is required to file 250 or more 1099s during the year, copies along with a transmittal form must be filed electronically with the IRS. The same reduced e-filing threshold for W-2s applies to 1099s starting with forms filed in 2021. Electronic filing is done through the Filing Information Returns Electronically (FIRE) system (employers must register to do this if they plan to file themselves).
Note: For W-2s filed in 2021 (reporting wages in 2020), employers can truncate employees' social security numbers (SSNs) (replacing the first five numbers with asterisks or XXXs) as a means of reducing identity theft. However, the full SSN must be used for forms transmitted to the SSA.
Why is it important for employers to correctly classify workers to the IRS?
It's essential that small businesses correctly classify their workers. Misclassifying an employee as an independent contractor can result not only in having to pay back 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 2019 Form W-2 in 2020: $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; $270 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.
Employment tax penalties may be avoided by using Section 530 relief. 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. And there's 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 for reporting non-employee compensation must be furnished to the service provider by January 31 of the year following the year of payment (e.g., January 31, 2020 for wages paid in 2019).
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 on Form 8809, but it's not granted automatically. There are five acceptable reasons for which the IRS will grant a non-automatic filing extension:
- The business experienced a catastrophic event in a federally declared disaster area.
- The business suffered a fire, casualty, or natural disaster affecting the operation of the business.
- There was a death, serious illness, or unavoidable absence of the person responsible for filing the returns.
- The information return is being filed for the first year the business is established.
- 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 any extension.
Taxing W-2 employees and 1099 contractors 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.