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The Difference Between a Employee (W-2) and a Contractor (1099)

Updated: Jul 15, 2021

Tax season is the time of year where most people look forward to filing taxes in hopes of a refund. It is also the the time of year where a lot of people get blind-sided by their employer paying them as an independent contractor, which makes them responsible for all their income taxes.

When you are an employee, your employer pays half your FICA (Federal Insurance Contributions Act).

  • Employer: 6.2% Social Security / 1.45% Medicare

  • Employee: 6.2% Social Security / 1.45% Medicare

When you are a Independent contractor, you pay all of it (15.3% of your reported income).

Employers are also responsible for FUTA (The Federal Unemployment Tax Act is a United States federal law that imposes a federal employer tax used to help fund state workforce agencies. Employers report this tax by filing an annual Form 940 with the Internal Revenue Service) , State employment taxes (varies by state), and state unemployment taxes. It is easy to see why a start-up or a small business may misclassify a worker to avoid paying all those employment taxes in addition to wages, especially when they are trying to increase profit margins. But larger companies are guilty of this as well. Sometimes worker misclassification is due to a lack of knowledge or misinformation, common with DIYers who self incorporate.

The best way to prevent misclassification is to be proactive and acquaint yourself with the IRS’s definitions. If in doubt, ask a tax professional. The U.S. Department of Labor, “employers may not misclassify an employee for any reason, even if the employee agrees.” When the IRS finds a business misclassifying employees as independent contractors against employment law, it will usually order the business to pay back-taxes as well as penalties for income taxes, Social Security, Medicare, and unemployment taxes.

Here are the "tests" to help decide between independent contractor or employee: 1. Behavioral control

The degree to which you exercise control over your workers’ time, work life, and tools affects how they’re classified by the IRS. Can the worker set their own hours, or does the employer assign hours? Who dictates how the work is completed?

2. Financial control

If the worker is paid a salary or guaranteed a regular company wage, they’re probably classified as an employee. If the worker is paid a flat fee per job or project, they’re more likely to be classified as an independent contractor.

3. Type of relationship

The type of relationship you have with the workers you hire also affects how they’re classified. Independent contractors are usually brought on for the short term, to carry out a set amount of work. If you bring someone on board for the long term and expect them to work for you indefinitely, they’re probably an employee.

If you’re genuinely not sure how to classify a worker, you can file Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding) to request a formal determination from the IRS on worker classification.

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