What is a W-2 Employee and How is it Different From 1099 Employees?
Whether you’re a freelancer, business owner, independent contractor, or regular employee, you’ll need to pay taxes. But knowing when, how, and how much to pay can be tricky.
Workers should stay informed about what they’re required to submit every tax season. There are tax deductions from an employee’s income that need to be accounted for. Employees need to get the correct tax form from the employer or fill out the correct tax forms on their own, so it’s important to get acquainted with the forms out there. One of the most important tax forms for employees in the US is IRS form W-2.
What is a tax form W-2?
IRS form W-2 (Wage and Tax Statement) is a tax form that reports how much was paid and how much tax was withheld. An employer is required to provide a completed W-2 form for each employee on their payroll. The employer must submit the W-2 form to the employees by January 31st of the current calendar year for the previous tax year.
What is a W-2 employee?
A W-2 employee is just a way to describe an employee. It means you’re on the company’s payroll and will get a W-2 form at the end of the year. Companies use W-2 forms to report the compensation paid to their employees each year—the keyword being employees.
As an employee, your employer is required to pay employer payroll taxes to the government and also withhold federal income tax from your paychecks (that’s why there’s a difference between gross pay and net pay). These additional withholdings include social security tax, medicare tax, and employment tax.
It doesn’t matter how long you worked with the company. If you were on the payroll and had taxes withheld, you will receive a W-2. For example, someone hired to work on a summer project might be called a W-2 contractor, because they’re working on a provisional, temporary basis. But they wouldn’t be considered an independent contractor in the legal sense if the employer has put them on the payroll and withheld taxes and contributions. Their income will reported on a W-2, not a 1099-NEC.
What are W-2 employee benefits?
The most obvious benefits of W-2 employees can be seen in payroll taxes. The employer pays half of the Social Security and Medicare taxes. If you were a contractor, you would be required to pay the employer’s share yourself.
W-2 employees also receive various employer-provided benefits, such as health insurance, paid time off, and retirement plans.
In addition to all this, W-2 employees have access to:
- Unemployment benefits
- Workers’ Compensation insurance
- Quicker paycheck delivery
- Less exposure to audits
- Operating on a written contract
- Being part of the team
1099 “employees” vs W-2 employees
While there are numerous differences between 1099 and W-2 employees, one stands out the most. They are used to report income for a different type of worker. IRS form 1099-NEC is issued to independent contractors to report income. So the term “1099 employee” is a misnomer—they’re not employees at all in the legal sense.
Form 1099-NEC is used to report the compensation the employer paid independent contractors. The contractor uses the 1099-NEC to report their annual income on their Schedule C tax return. They will then make tax payments on their total 1099 income.
Characteristics of the 1099 contractor
- Used for hiring independent contractors or self-employed workers
- The employer submits the IRS form 1099 when hiring the contractor
- 1099 employees pay their own taxes and contributions
- Allows more flexibility in claiming business expense deductions
- Requires the contractor to invoice the employer
- For irregular or project-based work
- Income reported on IRS form 1099-NEC
Characteristics of the W-2 employee
- Income reported on IRS form W-2
- Submitted to the employee and the IRS
- Employees don’t have to pay their own taxes; almost everything is already withheld from their income
- Provides less flexibility with additional deductibles since most of them are already paid by the employer
- Healthcare, SSA, and other benefits are determined in the contract and paid by the employer (the employee usually can’t choose which contributions they want, they receive the same ones as the rest of the employees in the company)
- Employees get paid faster since the company uses a unified payroll system and they don’t need to invoice the employer
Which is better for hiring new workers?
There isn’t a better solution between these two options. The choice the employer makes will depend on what kind of worker they’re looking for.
All employers deciding between forms W-2 and 1099 are making the choice between independent contractors and employees. Hiring an independent contractor is preferable if an employer is looking for help on a provisional basis, such as a new project that requires some extra hands that won’t be needed once the project is completed. Small business owners tend to use 1099 contractors because there’s no need to set up a payroll system. They can get temporary help for specific projects, instead of having to pay an employee year-round.
However, if an employer is looking for someone to help full-time, it is better to consider a more permanent relationship.
Employers should be careful not to misclassify an employee as a contractor. Not only will this cause significant issues with reporting taxes via the 1099 and W-2 forms, but it can lead to significant penalties.
Forms W-2 vs W-4: What’s the difference?
Don’t confuse W-4 and W-2 forms. The W-4 form is something the employee fills out when they begin a new job. It tells the employer how much tax should be withheld from their paycheck. The employer keeps the W-4 on file. There’s no need to complete one each year—only when your financial or living situation changes.
Further reading: What Is Form W-4?
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