Every employer has to submit annual wage reports to workers and file these reports with the Internal Revenue Service (IRS) or the Social Security Administration (SSA). The type of wage reports used for this purpose depends on the nature of the service provider, so employers need to determine whether someone who works for their company is an employee or an independent contractor.
Form 1099-MISC and W-2 Overview
Wages and other payments to employees are reported on Form W-2, while payments to independent contractors are reported on a Form 1099-MISC. Businesses need to classify their workers as either employees or independent contractors to file the appropriate form and avoid penalties. However, worker classification is not simple, so employers need to be careful and to understand the differences between forms 1099-MISC and W-2.
What Is Form 1099-MISC?
Form 1099-MISC is given to individuals and businesses if payments to an independent contractor during the calendar year total $600 or more, but it can be filed even if payments are less. For 2019, employers used Form 1099-MISC and entered payments to an independent contractor in box 7 for non-employee compensation. However, for 2020, employers use Form 1099-NEC and enter payments to an independent contractor in box 1 for non-employee compensation.
Many individuals or businesses can receive a 1099-MISC form. Some types of payments to individuals or businesses include:
- Services performed by someone other than an employee,
- Other income payments,
- Rent payments,
- Prizes and awards,
- Medical and healthcare payments,
- Payments to attorneys with exceptions,
- Payments to a business like a limited liability company (LLC), sole proprietorship, or partnership. On the other hand, corporations and S corporations, usually do not receive a 1099-MISC.
What Is Form W-2?
Form W-2 is an annual information return provided to an employee, listing taxable wages, income tax withholding and payments of Social Security and Medicare taxes. The form also includes various employee benefits as well as state income tax withholding. This form has to be filed by the employer for each employee, regardless of the amount of compensation paid during the year.
In light of the COVID-19 pandemic, employers with fewer than 500 employees are required to provide mandatory sick and family leave pay to employees unable to work because of the pandemic. According to IRS Notice 2020-54, employers have to separately report Qualified Sick Leave Wages and Qualified Family Leave Wages paid under the Families First Coronavirus Response Act (FFCRA) on 2020 Form W-2, Box 14, or on a separate statement. Therefore, it is necessary to ensure that Form W-2 reporting meets the new requirements.With this detailed guide, you can effectively manage tax responsibilities, remain compliant with changing regulations, and avoid tax errors and fines.
Differences between Form W-2 and 1099-MISC
Although the W-2 and 1099 forms are both information wage statements, the purposes they serve, and the types of worker classification they represent are different.
Form 1099-MISC is solely for payments to independent contractors and no tax payments are reported. On the other hand, Form W-2 is a more comprehensive information return, listing not only taxable compensation to employees but also federal and, if required, state income tax and Federal Insurance Contributions Act (FICA) withholding. Form W-2 also covers salary reduction amounts for contributions to 401(k) plans, certain employee benefit plans, other withholding, and various employee benefits.
In some situations, the same employee can receive both a 1099-MISC and a W-2. For example, this may happen if an independent contractor who provides services to the company is hired during the year to be an employee. However, businesses should be extremely careful when it comes to changing worker classification.
Classifying Workers Correctly to Avoid Repercussions
It is essential for every business to correctly classify their workers. Misclassifying an employee as an independent contractor can result in increased tax bills and penalties for not paying the appropriate employment taxes and for using the wrong form. Businesses may also be subject to penalties for failing to take appropriate state withholding and deductions, and not making contributions to state disability and unemployment agencies. The IRS may seek criminal penalties of up to $1,000 per misclassified worker while the U.S. Department of Labor can impose its own penalties.
The IRS uses three general criteria to determine whether an individual is an employee or an independent contractor: behavioral control, financial control, and the relationship between the worker and employer. Therefore, employers need to have a clear understanding of the business relationship between them and their workers and follow the IRS instructions for making the correct classification.
Correctly classifying workers and submitting the right information return to report payments to them can both go a long way in protecting businesses from troubles with the IRS. Also, employers can consider outsourcing tax management to optimize tax form processing. This ensures proper handling of workers and payments, in compliance with IRS rules, and puts an end to any tax errors and the resulting penalties.Handle increasingly complex tax compliance by automating tax management and ensure compliance with ever-changing tax laws and regulations.