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Almost any time you pay a worker, it creates an obligation to track their compensation for tax purposes. Your employees receive a Form W-2 from you at the end of the year, and you’ll need to prepare Form 1099 for any independent contractors or freelancers you work with.
But, how do you know which one to use?
What’s the purpose of a W-2 Form?
While the thought of having to file an ‘IRS-Form W-2’ might feel a little overwhelming, it’s usually a straightforward process. Also known as a Wage and Tax statement form, you simply use it to report the income an employee earns and the payroll taxes withheld from their compensation for the year.
When do you use form W-2 for an employee?
You may want to jot this note down: anyone you employ needs to receive a W-2 if they’ve earned more than $600 in a calendar year, or if they have had any taxes withheld from payments, requires a W-2. There’s no wiggle room: it doesn’t matter if they worked for one single day or if they are a family member. If the employee is full or part-time and paid more than $600, they must receive a W-2 form.
- Employers must provide a W-2 to their employees by January 31 of the following year
- In addition, employers need to file a copy of all employee W-2s with the IRS and the Social Security Administration
- Also, mark your calendar as employers must file all W-2 information with both federal agencies mentioned above by January 31 of the following year, but can request a 30-day extension if needed
What’s the purpose of a 1099 form?
There is no shortage of 1099 forms to keep track of, but one of the most commonly used by employers is the 1099-NEC, which stands for non-employee compensation. Like the W-2, 1099-NEC reports earned wages, but withholding such as medicare and social security are not. That is because 1099’s usually go to self-employed individuals such as contractors, freelancers, or gig workers. They are generally responsible for paying self-employment tax on their own. Keep in mind: if you do pay a contractor more than $600 in a calendar year, you must complete a 1099-NEC.
We should point out there are times a 1099-MISC form needs to be completed for any non-employee compensation. These could be items used for rents, prizes, awards, royalties, or other income payments, such as medical and healthcare. There’s a laundry list of them on the IRS website.
Who should receive a 1099 form?
If you frequently hire freelancers and independent contractors for projects, you need to provide them with a 1099 at years’ end. It might be seasonal help, freelance consultant or someone you just may not keep around forever. For example, let’s say you hire Danny Designer to create a brochure for your company, he would be considered an independent contractor. Danny should receive a 1099-NEC, provided his compensation is more than $600.00.
- Employers need to provide a completed 1099 to the contractor who received payment and file the 1099 with the IRS
- Both deadlines are January 31 of the following year
The IRS Test for employees versus contractors
When it comes to employees and contractors, the IRS has strict guidelines that take a long look at your working relationship. Unfortunately, there’s no special formula to determine the designation, but they do provide some guidance. Let’s take a peek at three categories they point out.
Behavioral Control. According to IRS rules, if an employer has control over an employee’s work performance, when and where they must work, provide detailed instructions on how to complete the work, or provide ongoing training, the person in question is an employee. Some roles this could cover include a director of information technology or a customer service professional.
On the other hand, if workers are free to complete a job on their own schedule, do not receive specific training, and accept projects on a case-by-case basis, they are contractors. Many people could fit the bill, such as freelance writers, consultants, or designers.
Financial Control. If you provide equipment or supplies for an individual to use or they receive a regular paycheck for a standard period of time, the person is an employee.
Contractors typically have their own equipment and resources to complete a job, such as computers and software. If the person in question offers similar services to other businesses, which they also provide you, they would be considered a contractor.
Working Relationship. Employees are eligible for company-paid benefits such as sick time, health insurance, and vacation pay, while contractors are not. The length of a relationship established can also help answer this question, with an indefinite relationship typically pointing to employee status.
As a small business owner, we know you have a lot on your plate. Remember that both W-2s and 1099 employees can be perfectly acceptable options – just be careful as misclassifying an employee as a contractor because it can result in costly fines. Not to worry: We break down the differences between W-2 employees and contractors to help you make sense of it all.