What are the major distinctions between a W-2 and 1099?
In this episode of Toni Talks, host Toni Covey, Director Of Professional Services, covers major distinctions between a W-2 and 1099.
We get this one a lot: “Should I use a W-2 or 1099?”
The answer to this question is that it depends. In some instances, you may not have a choice.
Let’s get into it.
Why Knowing the Difference between W-2s and 1099’s are Important?
Am I paying my workers as a W-2 or 1099? Which one should I do? Which one is best? The answer is that it depends. In some cases, you don’t have a choice of which one you’re going to do. Why is it even important for a business owner to determine if your workers are W-2 or 1099?
For starters, you have to think about tax penalties—everyone’s least favorite topic! If you misclassify and then come back to correct it later, technically, you filed late. There are penalties and fees for filing late, which can add up quickly.
Deciding on W-2 or 1099 determines what obligations you as a business owner have to that worker. The question is: to withhold or to not withhold.
The IRS has approximately 17 step tests that business owners can use. However, to avoid all that, it comes down to control. What’s the financial control?
What’s the behavior control that you have over this individual? Are you setting the time that they have to be there? How do they do their job? Do they have some flexibility? Do they get a vacation?
It’s looking at all of these different elements. The more control the individual has, the more they can be a 1099 employee. The more control the employer has, the more likely it’s a W-2 employee.
Even the IRS guidelines will tell you pretty straightforwardly that there’s no black and white.
Who Has Control?
If you exercise control over the worker in terms of their schedule, equipment, supplies and set their hours, they are a W-2 employee.
I will use the example of a receptionist. You have a receptionist that you hired, and you require them to come in every day, eight to five. You provide them with all of the supplies, and you’ve given them vacation benefits and things of this nature. That’s not a contractor; that is a W-2 employee.
For instance, when the receptionist is a contractor—especially these days with many people doing virtual offices—you don’t necessarily have control.
There are lots of services out there that offer virtual receptionist services. That would be a 1099 because that virtual receptionist is an employee of ABC Corp or wherever you’ve hired out to provide that service.
So you’ve contracted with that company, and they’re a contractor because you don’t necessarily control who’s picking up the phone for you every single time.
What are the obligations as an employer? The big one is the FICA tax. When you’re self-employed, we all know the self-employment tax, and it’s not like that tax just magically vanishes.
The IRS wants their pound of flesh. If you’re still employed, it’s just that the employer is now paying a portion of that versus you having to pay the entire portion of it.
Basically, it’s the withholding. As an employer, you are responsible for withholding and paying in your employee’s portion as well. If you have W-2 employees, you’re going to have to file the 941 quarterly and the 940 and W-2 annually. You also have to make your deposits and your quarterly payroll deposits. There also may be additional state obligations.
When we talk about W-2 employees, it’s also essential to note that now you have to look at the discriminatory rules related to retirement plans. If you have a retirement plan in the business and offer a medical reimbursement plan, or if you now are obligated to offer a group health plan, you have to look at things differently.
When I talk about discriminatory rules, I’m saying that if I have a company and I set up a solo 401 for my company, that’s fine because it’s just me and maybe my spouse. I can contribute to my heart’s content within limits to that retirement plan.
However, once I hire employees into my company, I can’t have a solo 401 anymore. I now have to offer participation to the employees in that plan with the same participation that I’m allowing myself when it comes to things like a medical reimbursement plan.
Suppose I have an unlimited reimbursement plan on the books for myself, and then I hire Jarom and Eliot. If Eliot decides to have calf enhancements done and submits for reimbursement and I had an unlimited plan, now my company’s got to reimburse Eliot a hundred thousand dollars per implant.
I have no idea how much calf implants cost. I’m sure I’m shooting over the moon on that, but you get the point. You have to offer them the same medical reimbursement plan that you have. If you’re going to limit it down to not paying any more than $10,000 a year for medical reimbursements, you—as the employer—will be limited to $10,000 for medical reimbursement. That’s only $5,000 per implant that you can expend.
Now, let’s say we’re not a W-2. Rather we’re a 1099.
Let’s give some examples of what a 1099 contractor would look like.
Often, it’s sales representatives. If you are a door-to-door salesman selling pest control or solar, you get to control your routes much of the time, and you get to control what hours they’re working. You are going to be a contractor at that point, as opposed to just a standard employee.
The easiest way you could distinguish when someone typically should be a contractor is if they have started conducting the activity in a business entity. You’re not W-2 in an LLC.
If, through my LLC, I’m providing services to different people, and we negotiate for rates, schedule, and workload. This puts the control in the contractor’s hands, as they dictate their terms.
Before we get to 1099, we need to make sure we have the information when the time comes to file a 1099. That means another for, more specifically, the W-9. Remember, with the W-2 employee, there are quarterly filings and two annual filings and only up to two on the 1099 contract workers.
If you’re going to fill out a W-9, you don’t need to file it with the IRS. But you need to have it on record so that when it is time to fill out 1099, you have the appropriate information to do so.
Many people have found that once they’ve gotten on the other side of that project and it’s time to fill out the 1099—and they don’t have a W-9—that contractor is not super willing to give them the information they need now to tell the IRS how much money they were given.
You want to get the W-9 filled out by the contractor before allowing them to begin work. If they don’t want to fill out the W-9, I’m going to recommend that you hire someone else.
As it pertains to the filing, you’re going to want to make sure you get that out to the contractor before January 31st.
The Takeaway
In short, how do I pay my workers—W-2 or 1099?
It will largely depend on benefits and control. It depends on whether you are setting schedules and providing benefits.
Hopefully, this helped clear it up. If you want to discuss this further, feel free to give us a call. We’ll get you scheduled with one of our professional advisors.
As always, take advantage of our free educational content and every other Tuesday we have Toby’s Tax Tuesday, a great educational series. Our Structure Implementation Series answers your questions about how to structure your business entities to protect you and your assets. One of my favorites as well is our Infinity Investing Workshop.
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