Which Form to Report Income—W-2 or a 1099-MISC?
Are you paying an employee or an independent contractor?
Employers are required to submit annual wage reports to workers and to provide them to the Internal Revenue Service as well. These statements detail their incomes for tax purposes so workers can accurately file their income tax returns.
But which wage reports do you give to which workers? First, you must determine whether someone who works for your company is an employee or a non-employee, then you'll know which report form to give that person.
Employees Receive W-2 Forms
Employees get W-2 forms. The difficulty is in determining whether workers are employees.
Most of your non-employees will be independent contractors. They'll normally have their own businesses separate and apart from your business. But it's not always that clear-cut.
The IRS uses three general criteria to determine whether an individual is an employee or an independent contractor: behavioral control, financial control, and the relationship between the worker and employer.
Does the company control what the worker does and how, when, and where the worker does it? If so, this is behavioral control.
Think of it like hiring someone to create a website for your business. Yes, you're telling him what you want to be done, preferably outlining the job in a contract, but if the job isn't one he wants to get involved with, he can always say, "No, thanks." An employee doesn't have this option...at least not if he wants to continue working for you.
You don't control when that independent contractor works on creating your website. He doesn't report to your place of business at hours you specify. You can't tell him to stop working on the website for a while and report to a shorthanded department to help out there.
Financial control applies to how the individual is paid. Yes, you might have a contract that cites how much you'll compensate the independent contractor for building that website for you. The contract will most likely state when your payments to him are due.
But again, he must agree to these terms. If it's entirely up to you when the worker is paid, how much he is paid, and whether you'll reimburse him for expenses, this indicates that you have financial control over the work he does for you. When you hire an employee, you tell him when payday is. He has no say in the matter.
Your Relationship With the Worker
Are there any employee-type benefits involved in your relationship with the worker? Think pension plans, insurance, and vacation pay. This indicates he's an employee.
Is the relationship open-ended or does he have a contract with you that specifies that it ends when a certain job is completed? Is the work that's performed a key aspect of your business? All these factors determine the type of relationship you have with the worker.
Benefits are provided to employees, and they work for you until you terminate their employment.
So Which Tax Form Should You Use?
Form W-2 reports total income and Social Security and Medicare Income paid to an employee. It shows how much has been withheld from her pay for federal, state, and local taxes.
W-2s are due to the employee no later than January 31. When you've completed and sent the W-2s to your employees, you must then send copies along with a compilation called a W-3 to the Social Security Administration.
Use Form 1099-MISC to report income you paid to independent contractors. You must only send an independent contractor a 1099-MISC if you paid him $600 or more during the year. You don't report withholding, Social Security, or Medicare wages on a 1099-MISC because you don't withhold income taxes for independent contractors.
Collect all 1099-MISC forms and send them to the IRS with a 1096 compilation form, just as you did with the W-3 form that went to the Social Security Administration for your employees.