COVID-19 has changed how small businesses operate, from applying for relief such as the Paycheck Protection Program (PPP) to updating payroll processes. Payroll—comprised of complex processes including garnishments and unemployment claims, payroll taxes, and classifying workers—doesn’t have to be confusing. By understanding payroll changes, payroll technology, and the ebb and flow of time and attendance, you can improve and simplify your payroll processes. WeWork Business Solutions, powered by VensureHR makes professional services simple, so you can revitalize your small business during this time.
Each year, employees wait for employers to process and distribute a financial summary of their employment over the past year. This information comes to employees in the form of either a mailed or digital W-2 or 1099 form. Aside from W-2 and 1099 being different tax forms used to deduct payroll taxes for different types of workers, this distinction may also have an impact on the amount of risk your business takes on.
As the number of new hires rises, especially given the emergence of the gig economy, employers are left to decide how to structure their business in terms of staffing. You will need to ask fundamental questions like, “How many employees will I need and for how long?” and “Will there be work available in 30, 60, or 90 days for my employees?” Here’s what you need to know about the different forms so that you can make informed staffing decisions.
Understanding the W-2 and W-3 forms
A W-2 is a tax form that outlines the total income an employee makes and the funds withheld from employee paychecks for the year prior. The information on the W-2 form helps the employee report annual wages, withholdings, and deductions to the federal government. Workers are required to file tax documentation for the previous year (e.g., W-2 forms from 2020 will be filed in 2021). The government uses the information on these forms to calculate the Social Security benefits to which each employee or worker is entitled.
W-2 forms will always have the same fields, regardless of the employer, the employee’s wages, the state where work took place, or the length of employment. The form is separated into two sections: state and federal. Some fields in each section are dedicated to identifying the employer from whom the employee earned wages, including the employer identification number (EIN) and the employer’s state ID number.
A W-3 is a document for employers to report the total income and salary they pay to all employees, total portion of funds subject to Social Security and Medicare tax, and the total taxes paid. Your W-3 should be submitted to the Internal Revenue Service (IRS) prior to January 31 each year, along with all other corresponding tax forms.
W-2 employer responsibilities
Employees are classified as W-2 employees, whether they are part-time or full-time, when the employer deducts taxes and uses the information on this form to file their (the employer’s) state and federal taxes. Upon hiring, employers have new employees fill out a W-4 form, or withholding certificate, which allows the employer to withhold the correct percentage of federal income tax from an employee’s pay.
As a business owner, you are required to send a copy of each employee’s W-2 to the employee and to the IRS. Since employees are required to file taxes prior to April 15 each year, you are required to send employees their W-2 forms on or before January 31 each year. Employers who misclassify workers could face huge fines and/or be liable to pay money owed to employees for this mistake.
Additionally, it is the employer’s responsibility to remain in compliance with any changes to deadlines and requirements. For example, on March 21, 2020, the IRS and the Treasury Department released special tax filing and payment relief as a result of the COVID-19 impact on businesses and individuals. This relief included an extension on the filing deadline for tax returns to July 15, 2020. Penalties and interest accrued on unpaid balances beginning July 16, 2020, and the extension was only applicable to federal income returns. It is integral for you to not only communicate this to your employees but also to understand how such changes may impact your business operations (e.g., distributing W-2s).
W-2 employer checklist
File employee W-2s directly with the IRS by using their Business Services Online. Other online processes include filing an electronic wage report, completing and printing up to 50 W-2 forms online (suitable for printing and distributing to employees), or completing and printing up to 25 W-2c forms online (also suitable for printing and distributing to employees).
Use this checklist to make sure you fill out the forms correctly.
☐ Ensure you are using the current tax forms
☐ Check to see if there were any tax law changes on any of the forms, including the W-4 forms
☐ Verify all workers have been properly classified as either employee or independent contractor
☐ Verify the distribution and filing deadline for the current year
☐ Review your current W-2 process
☐ Gather all relevant information
- Employer ID number
- Business name, address, zip code
- Company’s state tax identification number
- Full legal name, current address, social security/tax ID number
- Gross pay amount
- Federal income tax amount withheld
- Social security wages withheld
- Medicare wages, tips, and taxes withheld
- Paid employee tips
- Dependent care benefits
- State income tax withheld
- Local wages, tips, and income tax withheld
☐ File W-2 forms using accounting software, a payroll processor, like a professional employer organization (PEO), or a tax preparation service or software
☐ Check for errors, inadvertent failure to include important details, information in the incorrect form location (wrong box), or the failure to stop Social Security withholdings once the employee reaches the maximum
W-2 distribution and record keeping
Every January, employees who earned more than $600 during the year, regardless of business size, will start inquiring about their W-2 arrival. By this point, of course, business owners will have painstakingly submitted documentation and payments to ensure the W-2s are accurate and received on time.
Prior to mailing an employee’s W-2, the following data points must be confirmed:
- The spelling of each employee’s full name must be spelled correctly. Employee names must match the information on file with the Social Security Administration (SSA) or the employee will receive an error when attempting to file taxes.
- Each employee’s Social Security number must be accurate. This information must also match what is on file with the SSA.
Employers can use the verification service hosted by the SSA to verify legal names and Social Security numbers. The benefits of verifying employee information with the SSA prior to filing includes:
- More accurate wage reports
- Reduced number of corrected W-2s and any associated costs
- Faster verification than paper requests or by telephone
W-2s are due to employees no later than January 31 each year. Each W-2 form has six copies. You will retain copy D for business records and submit the remaining copies to the proper government agencies and the employee (copies B and C). The SSA must receive copy A before January 31, also. Failure to submit W-2s on time with the federal government can result in per-form penalties, up to $550 per W-2 employee.
Businesses are required by the IRS to keep employee W-2 forms on file for at least four years. You are welcome to keep the forms longer, but the IRS requires only a four-year history. The following documents should also be retained for at least four years:
- Tip reporting records
- Fringe benefits
- Federal tax returns
- W-2 form copy D
- Forms 940 (FUTA), 941 (Quarterly Return), 943 (Tax Return for Agricultural Employees)
- Form 1099-R (Distributions)
What is the 1099 form?
A 1099 form is required for those who classify as independent contractors or self-employed workers. When employers enter into an employment contract with a 1099 worker, the worker retains responsibility for maintaining records of hours worked, business-related deductible expenses (e.g., software, phone, fax, internet, etc.), taxes owed, and benefits. This is a significant difference from W-2 employees, as 1099 workers can be employed by multiple entities. They are required to follow different sets of laws and government regulations than W-2 employees.
In order to classify a worker as an independent contractor, the employer must identify various factors. The U.S. Department of Labor lists seven different characteristics to properly determine whether someone is an independent contractor or a self-employed worker. Examples include relationship permanency, contractor’s opportunities for profit and loss, and more. View the full list on the U.S. Department of Labor website.
Workers cannot be classified as 1099 workers if they receive tools and materials from the employer to do their job, if they receive company training for a specific part of their job, if they follow a set schedule, or if you provide employee benefits like paid time off, overtime pay, or health insurance. Jobs usually filled by independent contractors or self-employed individuals include healthcare workers, house painters, real estate agents, subcontractors, or accountants.
When it comes to tax season, in the case of an independent contractor, the worker is responsible for paying withholding taxes themselves. For this reason, many employers prefer hiring self-employed workers or independent contractors so they don’t have to deal with income tax withholdings, payroll taxes, and liability acts, and they have no obligation to offer employee benefits.
1099 employer responsibilities
When hiring a 1099 employee, or independent contractor, it is important that you are not forgetting the upcoming tax season and are focused on best practices regarding record keeping. The IRS has stringent policies around misclassification of a worker, resulting in stiff penalties and fines.
Use this checklist to make sure you are sufficiently prepared for filing this year’s taxes.
☐ Each 1099 worker should complete a W-9 form
☐ Collect tax ID information (e.g., Social Security Number) from the independent contractor
☐ File Form 1099-MISC before January 31 for each independent contractor
☐ Prepare an employment contract that includes:
- Project outline
- Expected project results, including project completion date
- Employer will not pay or withhold taxes
- 1099 worker will manage and/or obtain their own benefits
- 1099 worker will supply their own equipment
- 1099 worker possesses current skill set to complete aforementioned project
- Employer may terminate this contract if the independent contractor’s work is subpar
- Employer may terminate this contract if the independent contractor violates the terms of this agreement
☐ Payments against submitted, valid invoices
1099 distribution and record keeping
If you pay a contracted worker $600 or more over the course of a calendar year, you must file a 1099-MISC form with the IRS that outlines the amounts paid by the business to U.S. resident independent contractors before January 31 of every year. Each 1099 independent contractor will receive a copy of this form.
Employers are also responsible for filing a 1099-NEC (nonemployee compensation) form to the IRS, also by January 31 of every year, to report services a contractor performed. The 1099-NEC must be submitted with Form 1096, an annual summary and transmittal of U.S. Information Returns.
Like all tax information or details regarding the exchange of funds with an employee or an independent contractor, it is recommended that you keep all records, including W-4s, W-9s, and paid invoices, for at least four years after the employee’s departure.
1099 worker responsibility and deadlines
A self-employed individual has the benefits of setting their own schedule, picking the projects they want to work on, and the ability to work from wherever they’d like. At the same time, these contractors may have additional tax obligations throughout the year, and will not receive any employee benefits or employer protections. Since 2018, however, all workers are required to carry health insurance or pay a fee (Shared Responsibility Payment) when filing federal taxes.
Independent contractors are required to pay and file their own taxes on or before April 15 of every year. 1099 workers pay a 15.3 percent self-employment tax. A large portion of this funds Social Security and a much smaller portion goes toward Medicare. The worker is responsible for setting aside funds to make this payment come tax time, since the funds won’t be withheld throughout the course of the year.
1099 workers can deduct some business expenses, such as spending on their home office, work supplies, utilities, health insurance premiums, legal and/or professional subscriptions, and car mileage.
As a business owner, you will need to decide whether you prefer to have regular employees or whether you prefer to contract with self-employed workers. Deciding between hiring W-2 employees or contracting 1099 workers can be challenging. Take some time to understand the current state of your business and where you envision your business in the near future.
Small business owners can streamline payroll tasks like worker classification and filing and distributing W-2s by using WeWork’s Business Solutions, powered by VensureHR.
Julie Dower is a marketing and communications manager working for Vensure Employer Services, living in Chandler, Arizona. A mother to infant twin girls, she holds a master of science in technical communications from Arizona State University and a master of arts in English from Northern Arizona University.