1099 vs W2: Which Is Better for Employee?

1099 vs w2 which is better for employee

There are many different types of tax forms, which makes it understandable to see so many people getting confused between 1099 and W2. 

The two income tax systems correspond to two different types of employment, making it essential to differentiate between them. Whether you’re a business owner looking to form your own team or an employee, here’s what you need to know about the differences between 1099 and W2 tax forms.

The Difference Between 1099 and W2

The Internal Revenue Service (IRS) sets aside different forms for different kinds of income. Form W-2. also known as the Wage and Tax Statement, must be filed by the business owner. If they are engaged in a trade or business that pays compensation, including noncash payments, that exceed $600 in a year in payment to the services rendered by an employee. This also covers retaining employees satisfying the following conditions:

  • Employers pay taxes withheld for income, social security, and Medicare taxes.
  • Employees qualify for withheld taxes if they claimed no more than a single withholding allowance. This also includes those who had not claimed exemption from Form W-4.

This applies to regular employees, also known as common-law employees. Usually, the employer sends a copy of the Form W2 to every employee every year. This summarizes the employee wages paid and the withheld taxes. From the employee’s side, it is an important part of filing their own tax returns.

On the other hand, Form 1099 is actually an umbrella term covering different types of income taxes received as well as transactions aside from regular wages received by employees. Among the most common types of 1099 are Form 1099-NEC (Nonemployee Compensation) and Form 1099-MISC (Miscellaneous Income). For the purposes of this article, we’ll be focusing on 1099-NEC, which is commonly received by independent contractors, freelancers, gig workers, and other employees apart from those under common-law employment.

It is important to note that usually, working people in the country receive a combination of W-2 and 1099 forms. People receiving tax credits usually get 1099-H, while those with investments in stock have the 1099-DIV. Furthermore, Form 1099-NEC was recently established to separate freelancer income taxes from the 1099-MISC, which covers other income like prizes and honorariums.

1099 vs W2 Pros and Cons

There are different advantages and disadvantages to either option. Before choosing to become an independent contractor or a common-law employee, you might want to check the following considerations first.

Employee Benefits

Being a common-law employee is generally seen as being more stable than freelancing or independent contracting. A W2 employee is included on the company payroll and computation of payroll taxes. Additionally, they are generally entitled to the common benefits package—employment taxes, health insurance, and even programs relating to health and setting up retirement funds. Employers will pay payroll taxes and will withhold additional taxes as mandated by the law.

The same applies to retirement plans. Most employers help their W2 employees save for their retirement by offering 401(k) plans or anything similar. If you’re a 1099 employee, however, you’ll need to apply for and pay for these plans yourself.

On the other hand, freelancers and independent contractors do not enjoy the same benefits listed above. They have to pay for their own benefits and the workers’ compensation they receive is usually all-in, without any stipulations for allowances and benefits.

Onboarding and Offboarding

Usually, the employer is also in charge of onboarding processes for newly-hired W2 employees, which also translates to additional overhead expenses. The same goes for termination. Ending an employment arrangement with a W2 employee is usually more technical compared to freelancers.

Also, terminating a work arrangement with 1099 employees is a lot simpler compared to their W2 counterparts. Usually, when the project is done or the contracting services are no longer needed, the employer is free to stop enlisting the services of the 1099 employee.

Flexibility and Earning Potential

The main advantage of being an independent contractor is the freedom it allows, and with it, the earning potential. If you’re an independent contractor, you can serve multiple clients at once. This setup allows you to optimize your schedule and earn more than an average office employee.

On the other hand, being a common-law employee usually requires you to report to the site for a fixed number of hours per week. Whether there’s a lot to do or not, attendance is a necessity, especially since they’re paid per hour. This might feel counterproductive for some employees.

Work Expenses

If you’re hired as a W2 employee, you’ll be shouldering your own expenses. As mentioned above, the payment you will receive is expected to cover everything related to fulfilling the work you’re hired for. From your transportation to the tools and materials you will need, everything will come from your own budget. On the plus side, there are fewer restrictions about how you do your job—as long as you deliver the results expected from you.

If you’re a common-law W2 employee, most of the things you need are provided by the company. Depending on the job, you get your own office workstation or even a set of personal protective equipment (PPE). Some offices even offer additional amenities to help employees feel comfortable and stay focused—pantries, gyms, and even other recreational areas. Meanwhile, regular employees are also subject to the rules and regulations of the company. This usually includes the way employees are expected to conduct themselves and perform their jobs.

1099 vs W2 Tax Rates

Since these different employment arrangements use different income tax systems, expect to have different taxation systems for each of them. Generally, W2 employees pay only half of the 15% Social Security and Medicare Taxes. Employers pay half at 7.5 percent while the employee pays for the other half.

For independent contractors, however, it’s different. Self-employed individuals are legally recognized as separate taxable entities. As such, independent contractors pay the entire 15.3 percent—12.4% for Social Security tax, and 2.9% for Medicare.

1099 vs W2 Tax Rates for an Employee and an Independent Contractor

Additionally, it is important to clarify whether an employee should be filing Form W2 or 1099. In fact, the IRS has released a number of guidelines to help determine whether a worker is classified as a common-law employee or as an independent contractor.

The general rule is that for an independent contractor, the employer is limited to defining or determining the output of the employee’s work, and not the means of how the employee does the job. Essentially, independent contractors define how the work will be done.

Below are the three categories to help assess the degree of control your employer has over your work. Consequently, this also helps determine whether you’re supposed to be a W2 or a 1099 employee.

  1. Working Arrangement

Check the written contracts detailing the work arrangement you have with your employer. If it is not explicitly stated, you might want to refer to specific details such as the benefits offered or if there are mentions regarding permanency or tenure.

Also, it helps to understand if the nature of the work being offered is an integral or constant part of the business. If your work is contractual or for a temporary project, then it might be something under the 1099 form.

  1. Behavioral

This refers to the control exercised by the employer over the nature of the job. In an independent contracting arrangement, employers are usually restricted to the type and quality of output. This is usually negotiated during the job offering stage.

As for the materials and methodology, it’s usually left entirely to independent contractors. This also means that the employer is under no obligation to provide you with the equipment or means to get the job done.

  1. Financial

For this aspect, being independent contractors mean you’re also in charge of all your finances. From the filing of taxes and payment of benefits to reimbursement of certain expenses, it’s all under the contractor’s control.

About Worker Misclassification

Another important reason for understanding the difference between 1099 and W2 workers is the risk of employment misclassification by some businesses. Since companies can save more by hiring independent contractors instead of regularized, common-law employees, some business owners deliberately misclassify their employees as independent contractors or hire independent contractors instead.

It is important to recognize that there are instances of ignorance as to the cause of employee misclassification. Some employers, especially small businesses, might not be aware of the applicable labor laws regarding proper classification. They cut down on business expenses, social security taxes, and spare the effort needed to withhold income taxes and arrange employee benefits.

However, the unfortunate truth is that some employers willfully misclassify employees to save on costs. If a worker is labeled as a contractor instead of a regular employee, the employer can avoid paying government taxes and unemployment insurance. Remember that penalties for employee misclassification can be steep once the authorities establish the intent behind the criminal activity.

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