W-2 vs. 1099: How Do They Affect Payroll Tax Liabilities?

W-2 vs 1099

Imagine you just hired someone to join your company. But you aren’t sure if they’re an employee or an independent contractor. Knowing how to compare W-2 vs. 1099 employees is crucial when hiring people. That way, you can take on the right amount of tax liability and manage payroll correctly.

Keep reading to learn how these types of workers affect your payroll tax liability.

Employee Classifications

Classifying employees correctly can affect your payroll tax liability, and it can affect what you offer to individual workers. While you should consider if someone is full-time or part-time, you also need to compare W-2 vs. 1099 employees and contractors.

Taxes work differently for these two groups of workers, and you could face extra expenses if you don’t classify your employees accurately.

While you should have an idea of what classification employees have when you hire them, it’s important to review your relationship. If something changes between you and your employee, you may need to change their classification.

Consider how the IRS determines when someone is an employee or an independent contractor.

Relationship Type

The relationship you have with an employee can affect your employer tax liability. Consider if someone works at your office or remotely. Some employees work remotely, but most contractors don’t work at their client’s office.

A short-term relationship for a particular project usually signifies that someone is a contractor. However, if you hire someone to work for you long-term, they could be an employee.

But if you hire a contractor for ongoing work, they can still be independent. If you pay them per project, they would still be a contractor even if they work with you for years.

It may be hard to determine an employee’s status based on the relationship. However, it’s a good place to start before moving to finances and other factors.

Financial Control

You should also determine how much financial control you have when classifying employees. W-2 employees have to report their expenses to your accounting department, and you will usually reimburse them.

However, independent contractors are small business owners. When they incur a work-related expense, they need to cover the cost.

How you pay your W-2 vs. 1099 employees can also help you determine their classification. Many companies use direct deposit or a check to pay employees. But contractors may submit an invoice, or you might pay them through PayPal.

Another difference in finances comes with what determines someone’s pay rate. You typically pay employees a salary or hourly rate. However, contractors typically charge per project, regardless of how long it takes them.

Scheduling and Work Flow

If you set an employee’s schedule, you should classify them as a W-2 employee. Contractors typically set their own schedules and work from the place of their choice.

While all workers need to meet deadlines, 1099 employees have more control over when they do the work. They can work early in the morning or late at night. But traditional employees may need to come into the office during normal business hours.

The type of work you assign can also affect the right status for an employee. If you primarily assign one type of project, the worker is likely a contractor.

But if you expect someone to do various tasks outside of their main expertise area, they’re probably an employee.

W-2 Employees and Taxes

If you have W-2 employees, you have more payroll tax liability. You have to withhold taxes from your employees’ paychecks.

The taxes cover federal tax rates, and they include taxes for social security and Medicare. As the employer, you’ll withhold taxes based on an employee’s income.

You’ll also need to pay the same amount of social security and Medicare taxes for your W-2 employees. Traditional employees also need coverage for unemployment and workers’ compensation.

And if you have full-time employees, you may need to offer a retirement plan. Offering a 401(k) would require you to adjust tax withholding for employees who participate.

If you only have part-time employees, you may not have to worry about those things. However, you’ll still need to take out taxes and pay that amount to the IRS.

1099 Employees and Taxes

For businesses that don’t want to deal with employee taxes, 1099 employees are easy. You just give the independent contractor their full pay.

The contractor is responsible for paying federal and state taxes based on their income. They have to calculate how much they make working for you and any other clients they have.

You don’t have to worry about withholding taxes or paying extra for unemployment insurance or workers’ compensation. However, your contractors could sue you if they are injured on the job, and you’ll need to pay for that.

But you don’t have to offer benefits like health insurance or retirement plans to 1099 employees. Overall, your employer tax liability will be lower if you hire contractors over regular workers.

Why Classification Matters

Hopefully, the various differences have convinced you to accurately classify W-2 vs. 1099 employees. But if they haven’t, consider that you could face some hefty penalties.

The penalties are more serious if you classify employees as contractors. If you classify someone as a contractor when they work for you full-time, you may need to provide back pay.

You may need to increase your budget for benefits when you reclassify someone.

However, classifying contractors as employees could also affect you. By doing that, you may end up overpaying taxes and other things that aren’t necessary.

The more employees you have, the more you’ll have to manage and pay taxes. While you do get to withhold taxes, the money isn’t for your business, so avoid treating it as such.

Whether you have employees, contractors, or both, you need to manage your finances. That way, you won’t have to deal with surprises come tax time.

W-2 vs. 1099 Employees

When you hire people for your business, you need to consider if they will be W-2 vs. 1099 employees. Both classifications have pros and cons, so neither is always better.

However, you should consider how your employees work and how you pay them. That way, you can make sure you don’t misclassify anyone.

Do you need help with payroll management for your various employees? Request a consultation today.

Bryon Jennings

Bryon is the President of Next Generation Payroll and is business consultant who is focused on identifying solutions to common issues facing the small business community in an effort promote economic growth and sustainability.

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