The way the IRS distinguishes between employees and independent contractors guides what benefits a worker is entitled to, what tax obligations they’re subject to, and which paperwork is required to make their status legally sound.
Worker Classification (The BIG Question)
While the paperwork is important, the most important aspect of this whole conversation is making sure you get a worker classified correctly in the first place. The classification guides all other questions, including whether to file a W-2 or a 1099. It also determines whether the employee or the employer is responsible for withholding taxes, which labor and employment laws apply, and how the work gets paid.
Thankfully, the IRS provides some guidance guidance for determining how a worker should be classified. It considers how much control the worker has over how, when, and where work gets performed as well as whether/how much the employer provides in order for the work to be completed.
Employees Require W-2s
W-2: Wage and Tax Statement is a document that reports an employee’s gross earnings as well as the amount of taxes the employer withholds on said employees’s paychecks. Employers are legally required to fill out W-2s for any workers earning $600 or more in one year from whom they’ve withheld any taxes. The Social Security Administration receives a copy of the form as well as the state, city, or local tax departments. Employers retain one copy for four years.
The deadline to file W-2s with the SSA and provide copies to employees is January 31 of the year after the year of employment. Employees use the forms to complete their own individual tax returns and future social security and Medicare benefits are computed based on these figures.
Non-Employees Require 1099s
People who perform work for the company without being on the payroll require the Form 1099-NEC: Nonemployee Compensation. Note that as of 2020, the IRS no longer uses Form 1099-MISC.
While independent contractors keep track of their own tax obligations and file their own forms to the IRS, employers are still required to file a 1099-NEC for each person who is not an employee and was paid at least $600 during the course of the year.
Similar to a W-2, copies of the 1099-NEC of to the IRS, state tax agencies, and the independent contractor while the employer retains a copy. The 1099-NEC is also due January 31 the year after the work was performed.
Employers that need help making the determination can work with a partner (such as PayReel!) to make sure they get that status right or may wish to file Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding to let the IRS make the official determination. Since that process can take up to six months, any business that has frequent hiring needs may be better served by working with a partner (such as PayReel !) that is specifically qualified to make the determination and handle all of the associated risk and compliance issues as well.