Tax Season is Approaching: W-2s and 1099s
As the 2017 tax year is coming to a close, taxpayers will begin to gather their documents and records together so they can submit their tax returns.
Most taxpayers will have to report income from either a W2 or 1099 on their tax return. It is important to be aware of the differences of these two tax forms as they both can have a significant impact on your tax return.
Form 1099-MISC is an informational form that reports the miscellaneous income of a taxpayer. This form must be filed if a person is paid:
- at least $10 in royalties or broker payments in lieu of dividends or tax-exempt interest;
- at least $600 in:
- services performed by someone who is not your employee;
- prizes and awards;
- other income payments;
- medical and healthcare payments;
- crop insurance proceeds;
- cash payments for fish (or other aquatic life) you purchase from anyone engaged in the trade or business of catching fish;
- generally, the cash paid from a notional principal contract to an individual, partnership, or estate;
- payments to an attorney; or
- any fishing boat proceeds,
Personal payments are not reportable; only payments made in the court of trade or business are reported on Form 1099. A taxpayer is engaged in a trade or business if they operate for gain or profit. Generally, independent contractors must have their payments reported on Form 1099-MISC. Independent contractors are not considered employees so they do not receive W2s.
How do you determine if you are an employee or independent contractor?
This is based on the degree of control and independence between the employer and the individual. The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done. This determination is done on a case-by-case basis, but individuals can also file a Form SS-8 to have the IRS issue an official determination.
An independent contractor’s earnings are also generally subject to Self-Employment Tax (“SE Tax”). SE tax is a Social Security and Medicare tax primarily for individuals who work for themselves. It is similar to the Social Security and Medicare taxes withheld for employees that receive W-2s.
Under common-law rules, anyone who performs services for another individual is their employee if they can control what will be done and how it will be done. Per IRS guidelines, these are the steps necessary to determine how to classify the individual:
- Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
Form W-2 must be filed if an employer has an employee to whom payments were made for the employee’s services in the employer’s trade or business. Per IRS W-2 instructions, employers must complete and file Form W-2 if:
- The employer withheld any income, social security, or Medicare tax from wages regardless of the amount of wages; or
- The employer would have had to withhold income tax if the employee had claimed no more than one withholding allowance or had not claimed exemption from withholding on Form W-4; or
- The employer paid $600 or more in wages even if you did not withhold any income, social security, or Medicare tax.
The key difference between W2s and 1099s is that federal tax withholding. During the tax year, employers withhold federal tax (social security and medicare) for employees and the amount withheld is reported on Form W-2. Employees usually also have access to benefits such as access to a 401k, health insurance, and retirement plans.
It is important to ensure that you are not being misclassified as an employee or independent contractor. If you receive a 1099 when you should have received a W2 (or vice versa), contact your employer immediately. If an issue persists, you can also contact the IRS for additional assistance.