The government places the burden of tracking and taxing employees and contractors square on the employer. Every employer is required to track wages paid to individuals, and withhold and pay appropriate taxes as set forth by law.
The two most common employee classifications are W2 employees (traditional employees) and 1099 contractors (those who may work for other employers throughout the year). The rules and requirements vary between each type of classification.
What is a W2 employee?
The typical exempt or non-exempt employee that a business employs is known as a W2 employee. This employee works for the business and performs specific tasks based on the role within the company. These employees must be paid at least minimum wage and are required to pay federal and state income tax withholding, Social Security and Medicare payroll taxes. Businesses are required to match the FICA taxes and pay state and federal unemployment taxes on top of the wages that they’re paying to the employee. W2 employees can be offered benefits like PTO, retirement, and more by their employer. Each of these employees are required to receive a W2 Form from the company no later than January 31st each year.
What is a 1099 employee?
Businesses may choose to hire an independent contractor, or 1099 employee, to perform a certain job for that business. These 1099 employees are independent business owners and are not employed by the company. They are hired for a period of time and agreed upon fee set by a contract. 1099 workers may work for multiple companies throughout the year. Since these types of employees are not employed by the company, they do not need to be offered benefits. Businesses are not required to pay or withhold any taxes on behalf of 1099 employees as they pay self-employment taxes. The only tax requirement from an employers perspective is to provide 1099-NEC Form to these employees no later than January 31st.
Classifying your employees.
There are advantages and disadvantages to having either type of worker. Depending on the nature of your business, the job you need performed, or the length on time you need a particular employee for, one type of employee may be better suited for that position than another. From a tax standpoint, it is important to classify each employee correctly. Since businesses are required to match certain taxes that W2 employees pay, having W2 employees classified as 1099 employees will result in the business not fulfilling their tax obligations. Misclassification can lead to tax compliance issues for your business and result in hefty fines levied by the IRS.