What’s the Difference Between W-2 and 1099 Workers?

In 2022, Attorney General Racine filed a lawsuit against Arise Virtual Solutions and Comcast Cable Communications Management for failing to pay legally due wages to customer service agents.  With more than 22,000 workers affected, the U.S. Department of Labor calls this “the largest misclassification case in its history.”

Because they were misclassified as 1099 independent contractors, they were denied their legally required minimum wage and overtime pay mandated under the Fair Labor Standards Act (FLSA). 

 

W-2 vs. 1099 Forms

Forms W-2 and 1099 are tax forms employers must file on behalf of the employee or contractor. 

Every employer must file a W-2 for each employee in which income, social security, or Medicare tax was withheld. Employers send a copy of the W-2 form—also called the Wage and Tax Statement—to both the employee and the IRS. 

It’s important to keep in mind that independent contractors are not employees. For tax purposes, contractors fill out a W-9 upon hiring, while employees fill out a W-4. At tax time, HR will file a 1099 for each contractor and a W-2 for each employee.

What’s the Difference Between a W-2 Employee and a 1099 Independent Contractor? 

According to the U.S. Chamber of Commerce, “If you classify a worker as a W-2 employee, you are required to withhold Social Security tax, income tax, Medicare tax, and any state income taxes for the benefit of the employee. If you classify a worker as a 1099 independent contractor, they are responsible for paying federal and state taxes themselves.” That is the most important difference. 

Let’s look at an example of how W-2 vs.1099 classification functions practically.  

Your employee Lilly works full-time as a bookseller at your bookstore and makes $50,000 a year. As the senior bookseller, Lilly is given some extra flexibility with her schedule, but she still relies on you economically. 

At 7.65% FICA income taxes, Lilly would pay $3,825 in FICA taxes (withheld by you) and you as the employer would match that number. 

What would happen if you were to misclassify Lilly as a 1099 independent contractor? 

Your organization can avoid paying FICA, overtime, unemployment compensation, workers’ compensation, and various other employee benefits. Lilly would need to seek out health insurance and other benefits on her own. She would also be responsible for paying her taxes herself. 

How Do Independent Contractors Pay Taxes?

Because the IRS treats 1099 workers as self-employed individuals, their tax rules are different from W-2 employees. 

The 2024 self-employment or FICA income tax rate is set at 15.3% (12.4% for Social Security and 2.9% for Medicare), double the 7.65% rate for W-2 employees. Independent contractors will calculate their self-employment tax using Form 1040, the individual tax return form. 

Self-employment tax is not the same as federal and state income taxes. Independent contractors use the information on Form 1099 to fill out Form 1040. Form 1040 is used by all taxpayers to file their annual income tax returns and is then submitted to the IRS for review. Form 1040 gives the IRS the information they need to calculate federal income taxes. 

Because independent contractors are responsible for their own taxes, it becomes vital that they keep close track of their income and expenses throughout the year. Working with an accountant or a financial advisor can also help independent contractors take on tax season. For more information on how to file taxes as an independent contractor, check out the IRS’ list of tax obligations. 

It may seem that by misclassifying Lilly, you’re saving your organization money. However, the hefty penalties for misclassification, such as a $1,000 fine per misclassified employee and the potential of jail time, will prove much more costly to you and your organization. 

Many times, employees will be misclassified as 1099 workers and not even know it until they get a notice from the IRS that they owe thousands of dollars in taxes. As the HR pro at your organization, it’s your responsibility to make workers aware of their relationship to your organization before hiring. 

When Should You Hire an Employee vs. an Independent Contractor? 

When deciding whether you need to hire an employee or an independent contractor, consider the following questions:

• Is the work for this role ongoing? 
• Will the worker need to follow your organization’s policies and use your equipment?
• Will the worker require scheduled hours and/or a set location?
• Will you need to oversee/ manage your hire’s work?

It’s likely that if you answered ‘yes’ to the above questions, you should hire an employee rather than an independent contractor. 

Some examples of independent contractors include: 

• Freelance writers who get hired for short-term assignments
• Musicians who occasionally play gigs for your events 
• Consultants with specific start and end dates for projects

The IRS also sets out “common law rules” that provide evidence of the degree of control and independence in an employer-worker relationship:

• Behavioral Control: Does the company have the right to control what the worker does and how the worker does their job? This includes the type of instructions given, degree of instruction, evaluation systems, and training. 
• Financial Control: Are the business aspects of the worker’s job controlled by the payer or the worker? (these include things like how the worker is paid, whether expenses are reimbursed, who provides materials/supplies, etc.)
• Type of relationship: Are there written contracts or employee-type benefits (insurance, pension plans, paid vacation, sick days, etc.)? How permanent is the relationship? Will the relationship continue?

For more information, check out our blogs on how to hire and pay independent contractors and the DOL’s final rule on the classification of independent contractors. 

Additional Resources

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