📝 Overview
Worker classification determines your obligations as an employer, from tax withholding to benefits eligibility. Misclassifying a worker can result in penalties, so it's important to understand the distinction before setting up anyone in payroll.
🔑 W-2 Employees
W-2 employees have a formal, ongoing employment relationship with your company. As their employer, you are responsible for the following:
Tax Withholding: You are required to withhold federal and state income taxes, as well as payroll taxes (Social Security and Medicare), from each paycheck and remit them on the employee's behalf.
Benefits Eligibility: W-2 employees may be eligible for benefits such as health insurance, retirement plans, paid time off, and workers' compensation, depending on your company's policies.
Labor Law Protections: W-2 employees are covered by federal and state labor laws, including minimum wage requirements, overtime rules, and workplace safety standards.
Expense Reimbursements: You can reimburse employees for work-related expenses, and those reimbursements are typically not taxable to the employee.
Year-End Reporting: At the end of the year, you provide each W-2 employee with a Form W-2, which summarizes their annual earnings and total taxes withheld. Employees use this form to file their personal income tax returns.
🛠️ 1099 Contractors
1099 contractors are independent contractors or freelancers who provide services to your company on a contractual basis. They are not considered employees, and your obligations differ significantly.
Tax Responsibility: Contractors are responsible for paying their own income taxes, including federal and state taxes and self-employment taxes (which cover Social Security and Medicare). You do not withhold taxes from their payments.
No Benefits: Independent contractors are not entitled to employee benefits such as health insurance, retirement contributions, or paid time off.
Labor Law Coverage: Contractors are not covered by most labor laws that apply to employees, including minimum wage and overtime requirements. They manage their own work hours and conditions.
Expense Responsibility: Contractors are generally responsible for their own business-related expenses and can deduct those expenses when calculating their taxable income.
Year-End Reporting: If you pay a contractor $600 or more during the calendar year, you are required to provide them with a Form 1099-NEC or 1099-MISC, which reports their total earnings for the year.
⛔ Important Note: Misclassifying a worker as a W-2 employee or a 1099 contractor can have legal and financial consequences, including penalties for failing to withhold taxes or provide required benefits.
If you're unsure how to classify a worker, consult your accountant or tax advisor before proceeding.
⚙️ Setting Up a 1099 Contractor Profile
When onboarding a new contractor, you will need to answer two questions to complete their profile setup correctly.
⛔️ Important Note: If the contractor is unsure which option applies to them, they should consult a CPA or other tax professional.
Do you offer your services as an individual or a business?
As a business: Select this option if the contractor intends to file their 1099 through a sole proprietorship, LLC, or corporation.
As an individual: Select this option if the contractor will report their 1099 income on their personal tax return.
What type of tax identification number do you use?
Social Security Number (SSN): Format XXX-XX-XXXX. The contractor enters their personal SSN when filing as an individual.
Employer Identification Number (EIN): Format XX-XXXXXXX. The contractor enters their business EIN when filing as a business.
❓ Frequently Asked Questions (FAQs)
Find answers to common questions or additional details that may not be covered in the main instructions.
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How do I know whether to classify a worker as a W-2 employee or a 1099 contractor?
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Classification depends on the nature of the working relationship. Key factors include how much control you have over the worker's schedule, how work is performed, and whether the arrangement is ongoing. Because misclassification carries legal and financial risk, consult your accountant or tax advisor if you're unsure.
What happens if I misclassify a worker?
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Misclassification can result in penalties for failing to withhold and remit payroll taxes, as well as liability for unpaid benefits. The IRS and state agencies take worker classification seriously, so it's important to get it right before the worker begins.
Can a contractor be set up as both an individual and a business?
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No. When setting up a contractor profile, you must select one option: individual or business. The selection determines which tax identification number is required (SSN for individuals, EIN for businesses). If the contractor is uncertain, they should speak with a CPA or tax professional before onboarding.
Does the platform issue 1099 forms automatically?
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Year-end 1099 filing is managed through the payroll platform. Refer to the year-end resources in the help center for specific guidance on 1099 preparation and filing timelines.
Do I need to withhold taxes for a contractor set up as a business?
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No. Regardless of whether a contractor is set up as an individual or a business, you are not responsible for withholding or remitting taxes on their behalf. Tax responsibility falls on the contractor.