If you’re starting your first business, you may find it difficult to understand employment taxes from an owner’s perspective. If you worked as an employee, you were issued a W-2 and your employer withheld and submitted federal and state taxes on your behalf. You picked up the tax withholding amounts from your W-2 and posted them to your personal tax return.
This process is more complicated as a business owner, however. An owner must determine if each worker is an employee or an independent contractor. Business owners must also withhold taxes on employee wages, and deal with estimated tax payments on company profit.
1099 or W2? The Distinction Is Important
Many businesses have workers that are classified as employees and others who work as independent contractors. The distinction is important, because it affects how income taxes are withheld and paid.
The IRS requires employers to determine if a worker is an independent contractor or an employee. The guidelines address how much control the company has over the worker, such as control over what the worker does and how they perform their work. The less control a company has, the more likely it is that the worker is classified as an independent contractor.
Companies must withhold federal, state and other taxes from employee wages and submit those amounts to the proper taxing authority. Independent contractors, on the other hand, are responsible for their own federal and state taxes.
As an example, assume that Silverscreen Productions hires Julie as a freelance producer. Julie hires a cameraman, write scripts, plans video shoots and edits the video that is shot. Since the producer controls when and how the work is performed, Silverscreen’s CPA determines that the producer is an independent contractor, which means that no worker taxes are withheld by the company.
Silverscreen also hires Joe as an executive assistant for the company president. The president closely manages Joe’s work, and the firm’s CPA determines that Joe should be classified as an employee.
To make this determination as simple as possible, we created a 1099 vs. W2 wizard. Just answer a few simple questions and it will tell you how to classify your workers.