Employer obligations in the United States vary for 1099 contractors vs W-2 employees. Moreover, misclassifying someone as a 1099 independent contractor when they should be a W-2 employee can be costly for businesses.
This seemingly simple paperwork decision for tax compliance and reporting can trigger severe financial and legal ramifications. Thankfully, we are here to take you through the appropriate use of 1099 and W2 tax forms and also provide answers to how much taxes does an independent contractor pay.
IRS Compliance: Independent Contractor vs Employee Taxes
Below listed are popular tax compliance forms recommended by the IRS:
| When You Are An Employee |
When You Are An Independent Contractor |
- Form W-4, Wage and Tax Statement: Used by employees to suggest how much taxes can be withheld from their salary for the year
|
- Form W-9:Used by your employer to request a Taxpayer Identification Number (TIN) for tax deduction and reporting purposes
|
- Form W-2, Wage and Tax Statement:Based on W-4, businesses report salary paid and taxes withheld for the year
|
- Form 1099-NEC/K:Used to report income received from various sources, exceeding $600 annually
|
- Form 1040:The main form for filing federal income taxes by US individuals
|
- Schedule C:Used by sole proprietors to report business income and expenses
|
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What defines a 1099 Contractor?
Anyone who is a freelancer, independent consultant, or platform worker is a 1099 contractor, most commonly referred to as an independent contractor or self-employed worker.
They can be an individual or business that provides services to a company but is not considered a regular employee. The following characteristics define 1099 contractors:
- A 1099 contractor has the flexibility to choose when and where they work, unlike employer-provided schedules.
- They acquire and maintain the necessary tools and equipment needed to complete their projects.
- A 1099 contractor is responsible for securing new work and clients, unlike a W-2 contractor or employee who receives a steady stream of work from their employer.
1099 Independent Contractor Agreement
If you are looking to hire and engage contractors in the USA, consider drafting an agreement outlining project milestones and deliverables. Further, you can use the W-9 form and 1099 form for tax compliance and reporting purposes.
Here’s a useful guide to filling out a 1099 form for independent contractors.
Who is a W-2 Employee?
A W-2 employee is an individual who is formally hired, works for a company that sets their schedule, and extends statutory benefits. Here are some key characteristics that define a W-2 employee:
- Subject to a significant level of control, including a predetermined work schedule, training and supervision, and following specific work methods and procedures outlined by the employer.
- Enjoy employer-provided benefits such as health insurance, paid time off, and retirement contributions.
- Need not pay self-employment taxes but are still responsible for filing a federal income tax return (Form 1040).
For tax compliance and reporting, you may need both W4 and W2 forms.
W2 For Contractors
The popularly used term, W2 independent contractor is a misnomer. It is because the temporary staffing scenario creates a situation where someone can be an employee for tax purposes (to the agency) while acting as a contractor for the client company they work for.
There's no such thing as a W 2 contractor. This further highlights the importance of understanding worker classification based on the level of control, financial investment, and relationship to the business and avoiding misclassification.
Do Independent Contractors Get W2 Status?
1099 contractor vs W-2 employee statuses are mutually exclusive for tax purposes. You cannot classify a 1099 contractor as a W-2 employee (or vice versa) without altering the level of control, and financial investment within the employment relationship.
You may learn more about switching from 1099 to W2 status and avoid penalties linked to misclassification.
Key Differences Between W2 vs Independent Contractor
| Feature |
W-2 Employee |
1099 Contractor |
| Employment Relationship |
A formal employee of a company, full-time or part-time |
Self-employed business |
| Tax Form |
Receives a W-2 form at year-end |
Receives a 1099 form annually (i.e. 1099-NEC) |
| Taxes |
Employer withholds income taxes, Social Security, and Medicare from paychecks |
Responsible for paying self-employment tax (covers Social Security & Medicare) and estimated taxes quarterly |
| Benefits |
Typically receives employer-provided benefits (health insurance, paid time off, retirement contributions) |
Generally does not receive employer-provided benefits |
| Control & Schedule |
Employer dictates work schedule, provides training and supervision |
More autonomy over work schedule, methods, and tools used |
| Classification |
Clear-cut employee classification |
Classification depends on the level of control exerted by the hiring entity |
Do Independent Contractors Pay More in Taxes?
Let’s draw a general comparison of taxes for independent contractor vs employee.
| Comparison |
1099 Contractor |
W2 Employee |
| Tax withholding |
They receive a 1099 form summarizing the payments made to them throughout the year. |
Employers withhold income taxes, Social Security taxes, and Medicare taxes from salary. |
| Taxes owed |
Pays self-employment tax, which covers both Social Security and Medicare at a combined rate of 15.3% in 2024. |
Federal income tax depends on the employee tax bracket when you file your return. Social Security and Medicare taxes are typically already covered. |
| Tax advantages |
1099 contractors can claim several deductions under business-related expenses and this could result in a lower tax bill. |
The W4 form allows employees to determine how much taxes can be withheld from salary throughout the year. |
| Tax consideration |
Need to make estimated tax payments quarterly to avoid penalties. Keeping good records of income and expenses is crucial for accurate tax filing. |
Less paperwork and tax planning are involved as the employer handles most of the withholdings and reporting. |
Independent Contractor Pay Rate In The US
There cannot be a straightforward explanation for determining the pay rate for the 1099 contractor vs W2 employee. While the salary of W2 employees is fixed, independent contractor pay rate varies based on factors like project complexity, experience & skill, or location.
Thus, independent contractors do not necessarily pay more in taxes than employees. Still, they do have a different tax responsibility structure based on their pay rate (the annual threshold for tax liability is $600).
Awarding 1099 vs W2 Contractor Status
Listing down the benefits of hiring independent contractor vs W2 employee:
| 1099 contractors |
W2 employees |
| Reduced administrative burden (no tax withholding or benefits) |
More control over work and employee development |
| Greater flexibility for project-based work |
Increased loyalty and commitment from employees |
| Access to specialized skills without hiring full-time employees |
Access to a pool of talent readily available for future projects |
IRS also provides Form SS-8 to help you classify someone working for you as an employee (W-2) or an independent contractor (1099). This can help you avoid any potential issues with misclassification down the line.
Get Paid as a 1099 Contractor or a W2 employee, Easily with Skuad
Your contractors and employees may insist on a one-stop shop for a seamless and efficient payment experience. And here’s why Skuad shines for both contractors and employees:
- Automate Payments for Contractors: No more chasing invoices as Skuad streamlines the payment process for contractors through fast and secure access to earnings through multiple withdrawal methods.
- Simplified Payroll for Employees: Skuad handles all the complexities of payroll deductions and compliance with local labor laws, ensuring timely and accurate salary payments.
Get started with a free demo and expand your global team!
FAQs
1. Is it better to be a W-2 or 1099 employee?
Employer priorities may dictate the best option between W-2 or 1099 status. While W-2 employees experience job stability, statutory benefits, and regular paychecks, 1099 status provides more work flexibility, but with no statutory benefits.
2. Why do companies use 1099 employees?
The common practice among companies is to hire 1099 contractors to save on payroll costs. They do so while scaling their workforce for specific projects, accessing specialized skills without full-time commitment, and reducing management overhead.
3. How does a 1099 employee pay taxes?
1099 contractors are responsible for paying all their taxes, including self-employment tax (covering Social Security and Medicare) at a rate of 15.3% in 2024.
4. Is it better to pay employees 1099 or W-2?
Companies may decide to pay employees 1099 or W-2 based on their project needs, budget, and desired level of control over the work. For companies, 1099 can be more cost-effective than W-2 employees but risks misclassification penalties.
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