What to do with W-2's and 1099's

When you start employing others in your business, a whole new world opens up within tax liability and responsibility. With you new tax liabilities comes a lot of paperwork to send to the IRS. The paperwork discussed here will be W-2's and 1099's. So you have a decision to make. Does the work you need preformed by others going to require employees or should you hire independent contractors instead? Answering this question will determine what you do with W-2's and 1099's so let's see what the difference is and what you are responsible for with each.

W-2 Employees

Hiring employees on W-2 status is the most common and most expected way to go to work for someone. When a person is paid by W-2 status, the employer will automatically withhold and pay all the employment taxes required by the IRS. At the beginning of employment and every year a person works for you, you give your employees a W-4 to fill out and return to you to help you determine what you should deduct by way of taxes. This means that you are responsible for determining how much to deduct from each of your employees' paychecks and sending it to the IRS on a monthly or semi-weekly basis depending on the size of you business. You are also responsible for matching the deductions you've made from your employee's paychecks and sending your matching contribution to the IRS. When you employ others, you are also responsible for paying unemployment taxes. The federal employment taxes include: income tax, FICA taxes (Medicare and Social Security), and federal unemployment tax. You are also responsible to deduct and pay state taxes, including the state unemployment tax which your employees are not responsible for.

At the end of the year the employer is also responsible for filing out a W-2 for each of their employees, correcting any mistakes that may have been made on withholdings throughout the year, and sending one copy of the W-2 to the employee and one copy to the IRS before the end of January following the tax year. Being employed as a W-2 employee makes things easier, but the employer does have a lot of work to keep things organized and running properly.

1099 Independent Contractors

Having employees work on a 1099 basis means that you are actually hiring an independent contractor rather than an employee. This has its pluses and drawbacks.

The pluses are that you are not responsible for withholding and paying federal or state taxes for that particular person. They contract with you to perform a specific job or duty and when it is finished, you pay them for the work done. You still have to report what you paid them through a 1099 at the end of the year and send them and the IRS a copy of the 1099 form, but that's the end of it for you. All the tax liability rests on the independent contractor's shoulders. This frees you from having to figure out deductions and percentages as well as having to match whatever you withhold from your employees' paychecks, but it can come with a price.

Some of the drawbacks to employing others on a 1099 basis are that contracting work out holds risk. If the contractor doesn't feel that you held up your end of the contract, you could end up in court. Independent contracting doesn't inspire a lot of loyalty either. You don't offer the contractor benefits, bonuses, or paid holidays as you would a regular employee, so you may end up paying them more than you would a regular employee just to stay competitive. There is some work that requires an independent contractor and some that doesn't, so choose wisely when you start employing others.