As of 2023, roughly 39% of American adults have both a full-time job and a side hustle. As a result, it’s become trickier than ever for many to answer the question: are you a W-2 employee, an independent contractor, or something else?
Understanding whether you qualify as a W-2 employee is essential, as it directly impacts critical issues like tax responsibilities and access to benefits. Let’s clarify the definition of a W-2 employee for you and explore its most significant implications.
What is a W-2 Employee?
A W-2 employee is someone officially hired by an employer to perform services for them on a full-time or part-time basis. Critically, W-2 employees give control over what work they do and how they do it to their employers.
The "W-2" designation comes from the Internal Revenue Service (IRS) tax form employers use to report the wages they pay their employees, officially known as Form W-2. Here’s what it looks like:
Form W-2 is primarily meant to help employees report the correct gross income and tax withholding amounts on their annual tax returns. If you get a copy each year, your employer considers you a W-2 employee.
In most cases, their opinion is the only one that matters. If your employer calls you an employee, you can usually assume they’re correct and manage your finances and tax responsibilities accordingly.
However, it’s important to note that an organization calling you their employee isn’t legally sufficient to make the designation stick. Your relationship with them has to meet the actual definition of employment, which we’ll explore more later.
1099 vs W-2 Employee
The W-2 employee classification stands in direct contrast with the “independent contractor” designation. Independent contractors are also commonly referred to as 1099 contractors or, incorrectly, as 1099 employees.
Independent contractors are not employees. In fact, they’re the opposite. They’re self-employed individuals and legally characterized by the fact that they maintain control over what work they do and how they do it.
In addition, independent contractors don’t receive W-2 forms. Instead, they get various 1099 forms from their clients and the payment platforms they use. In 2024, the most common 1099 forms include Form 1099-NEC and Form 1099-K.
What Does it Mean to Be a W-2 Employee?
Qualifying as a W-2 employee typically impacts your day-to-day work experience, tax responsibilities, and legal protections. Let’s review the implications you need to understand as a member of the American workforce.
Work Experience
Generally, the fundamental distinction between W-2 employees and independent contractors is that W-2 employees don’t control the work they do or the manner in which they do it. That control rests with their employers, even if they don’t always use it.
In contrast, independent contractors may get hired to achieve specific objectives, but they retain their autonomy. In fact, the businesses that engage their services often need their unique expertise and are happy to let them operate as they see fit.
For example, say you’re a graphic designer working in-house at an agency as a W-2 employee. You report to your employer’s office each weekday at 9:00 am and work on projects your employer assigns, completing them to their specifications.
In contrast, you know a former coworker who does graphic design work for several clients as an independent contractor. They work remotely, whenever and wherever they decide, and complete the work requested however they see fit.
Tax Responsibilities
W-2 employees and 1099 contractors face very different tax situations. Employees tend to have much more straightforward returns and fewer tax responsibilities in general. Their employers handle most of the work.
For example, some of the most significant differences revolve around the following:
Paying taxes: Unlike self-employed people, employees don’t have to make quarterly estimated tax payments. Instead, employers automatically withhold federal and state taxes from their W-2 wages and send them to the appropriate tax agencies on their behalf.
Bookkeeping: Employees can't claim tax deductions to reduce their taxable incomes. As a result, there’s little benefit to keeping track of their expenses, so they don’t have to worry about bookkeeping nearly as much as an independent contractor.
Tax returns: Self-employed people often have to file tax returns for their businesses as separate legal entities. At a minimum, they typically must complete Schedule C to report their business activities. In contrast, most employees only have to complete Form 1040, the basic individual tax return.
If you’re an employee with no other sources of income, your only real tax responsibilities are to report your W-2 wages accurately and file your returns on time. It’s easy enough that you probably don’t need to hire a Certified Public Accountant (CPA) for help.
Benefits and Protections
Last but not least, W-2 employees typically receive significant legal protections that don’t extend to 1099 workers. For example, in addition to the tax advantages mentioned previously, some of the most notable benefits to being a W-2 employee include:
Health insurance: Employers with more than 50 full-time equivalent employees must offer them health insurance that meets the coverage and affordability requirements in the Affordable Care Act.
Unemployment benefits: Employees who lose their jobs through no fault of their own can benefit from unemployment insurance, which provides them temporary financial assistance.
Minimum wage and overtime pay: Employees are entitled to a minimum rate of pay. Most are also entitled to 1.5 times that hourly rate for each hour they work beyond 40 hours per week.
These legal protections for employees are a significant part of why it’s so important for Americans to understand their working classification. If you qualify as an employee but get misclassified as an independent contractor, you may need to fight for your rights.
W-2 Employee or 1099 Contractor: How to Determine Your Status
Ultimately, you're responsible for ensuring the businesses you work for properly classify you as a contractor or employee. To help you do that, let’s look at the IRS and DOL guidelines for determining which camp a worker belongs in.
Internal Revenue Service Guidelines
According to the IRS, whether a worker should be considered a W-2 employee or an independent contractor depends on whether the employer has a right to control the work they do and how they do it.
When making that determination, there are three primary factors to consider:
Behavioral control: This refers to the degree of control the employer has over what the worker does and how they do it. Generally, the more detailed the employer’s instruction, training, and evaluation of the worker, the more behavior control the employer has over them.
Financial control: This refers to the extent the business controls the economic aspects of the worker’s job. Generally, employees invest less capital in their work, get reimbursed for expenses, have less opportunity for loss, can’t seek other business opportunities, and get paid a regular wage.
Relationship between the parties: This refers to additional factors that color the perception of the relationship between the worker and employer. For example, that includes the presence or lack of written contracts, how long the relationship lasts, and whether the worker’s services are critical to the business.
Remember, these are all factors designed to help you determine whether an employer has the right to control what their workers do and how. Even if the business doesn’t exercise that control, its existence is enough to constitute employment.
Department of Labor Guidelines
In recent years, the DOL has proposed multiple rulings that would have changed its standards for determining whether an individual qualifies as an employee or an independent contractor.
However, its most recent ruling, which was issued on January 11, 2024, and took effect on March 11, 2024, returned things to the previous status quo. It states that you should use the following six factors to make the employment determination:
Worker’s opportunity for profit or loss that depends on their skill
Investments in the business made by the worker and employer
Degree of permanence to the relationship between the two parties
Nature and degree of control the employer has over the worker
Extent to which the worker’s job is integral to the employer’s business
Whether the worker shows initiative and uses specialized skills to do their work
The rule also states you should consider these factors with a “totality of the circ*mstances'' approach. In other words, you shouldn’t give any of them more weight than the others.
Instead, consider them holistically to determine if “economic dependence” is present. If a worker is economically dependent on an employer, they should be considered an employee. If not, they’re an independent contractor.
Can You Be Both a W-2 Employee and a 1099 Contractor?
If you’re one of the many Americans with a full-time job and a side business, you may not be sure which worker classification applies to you. Fortunately, it’s pretty simple: You’re both an employee and an independent contractor.
Your employer will need to treat you as a W-2 employee. That means they should withhold taxes from your wages, offer you health insurance, pay you a minimum wage, and send you a W-2 form each year.
However, your business clients should treat you like an independent contractor. You’ll retain control over what services you offer and how, but you’ll also be responsible for things like estimated tax payments and won’t receive benefits like health insurance.
Using Found for 1099 Income
If you’re one of the many W-2 employees earning 1099 income through a side hustle or business, it can be tricky to keep your finances organized, especially if you only have one bank account.
To simplify things, you should always have a separate bank account for your business transactions. That makes it much easier to identify your business income and expenses when you file your tax return.
If you’re in the market for a business bank account, one of the best options is to use Found! Our platform is designed specifically for the self-employed and has a host of features that can automate processes like:
Tracking your business income and categorizing deductions
Setting aside money for estimated tax payments
Filling out your business tax forms, including Schedule C
Best of all, you can get started for free! Sign up for Found today and let our software streamline your finances so you can focus on doing what you do best.
FAQ
What is a W-2?
Form W-2 is the tax form employers use to report the wages they pay to their employees and the federal taxes they withhold from their paychecks. Employers must send a copy of the form annually to each employee and the IRS by January 31.
What is a 1099 Contractor?
A 1099 contractor is a self-employed individual who does work for a business in a contract capacity. They retain control over what work they do and how they do it, making them the direct opposite of an employee.
What is the Difference Between W-2 and 1099 Forms?
W-2 and 1099 forms are both used to report a worker’s income to the worker and the IRS. However, employees get W-2 forms from their employers, while independent contractors get 1099 forms from their clients and third-party payment platforms.
Is 1099 Better Than W-2?
Being a 1099 contractor isn’t inherently better than being a W-2 employee. There are pros and cons to both classifications. Generally, 1099 workers have more autonomy, but employees benefit from stronger legal protections.
Disclaimer: The information on this website is not intended to provide, and should not be relied on, for tax advice.
