What is a W-2 employee?

For business owners and payroll managers in the United States, understanding the specifics of W-2 employees—workers who receive a W-2 tax form from their employer—and how they differ from 1099 workers is key. It ensures adherence to Internal Revenue Service (IRS) guidelines, helping to avoid penalties and maintain compliance with federal tax laws.

In this guide, we’ll explore the distinctions between W-2 and 1099 employment classifications, their respective tax obligations, and the benefits associated with each. We'll also provide practical tips for accurately classifying workers to ensure your business stays compliant with IRS regulations.

What is Tax Form W-2?

Form W-2 provides a detailed record of an employee's annual earnings and taxes withheld from their pay, including federal, Social Security, Medicare, and any applicable state and local taxes. Additionally, W-2s detail pre-tax and post-tax deductions, like 401(k) contributions, and include critical information such as the employer's tax identification number (TIN). This form is essential for both the employee and the employer as it helps in preparing other tax documents, such as Form W-3, and enables workers to file their income taxes with the IRS. 

The IRS mandates that all U.S.-based businesses issue W-2s to their employees, regardless of whether they are part-time or full-time, or if they work in-person, remotely, or in a hybrid model. Non-U.S. citizens working for U.S. companies may receive both a W-2 and a Form 1042-S, depending on their specific situations.

What are W-2 employee benefits?

Employee benefits are essential to attracting and retaining top talent. They form an integral part of a worker’s total compensation package and typically include:

• Health insurance: Most people in the U.S. who have health insurance receive it through their employer as per the Affordable Care Act (ACA), which mandates that employers with 50 or more employees must provide them with health insurance benefits.
• Sick leave: Many states require employers to offer paid sick leave, which allows ill employees to rest and recover at home while keeping everyone else in the workplace safe.
• Workers' compensation insurance: Most states require employers to offer workers' compensation, which covers lost wages and medical expenses if an employee is injured or becomes ill due to their job. Some states also require disability insurance for non-work-related injuries or illnesses.
• Unemployment insurance: Employees who lose their jobs through no fault of their own may be eligible for unemployment benefits. Employers contribute to these funds under the Federal Unemployment Tax Act (FUTA), with some states imposing additional unemployment taxes.
• Retirement plans: While employees typically manage their retirement savings, some states have implemented regulations requiring companies to offer retirement plans or contribute to them, helping employees prepare for their golden years.‍
• Paid and unpaid time off: Although not required by federal law, many companies provide their W-2 employees with a set number of paid vacation days annually. Also, the Family and Medical Leave Act (FMLA) grants employees the right to take unpaid leave for specific family and medical situations.

Understanding Form W-2 eligibility

Below are the key characteristics of W-2 employees that differentiate them from contingent workers such as independent contractors and freelancers (who receive Form 1099):

• How they manage their taxes: Employers are responsible for withholding taxes from the paychecks of W-2 employees. This includes payroll deductions for federal income tax, Social Security, and Medicare.
• How much autonomy they have: Employers have the authority to direct when, where, and how W-2 employees do their work. They must also supply and maintain all necessary tools and equipment the job requires.
• How consistently they work: W-2 employees typically enjoy a consistent flow of work and receive compensation regularly based on a set salary or the number of hours or days worked.
• What types of benefits they receive: W-2 employees often qualify for various mandatory and optional benefits, such as health insurance, retirement plans, sick leave, and paid vacation.

The difference between 1099 vs. W-2 employees

Although they might perform similar tasks, there are significant distinctions between W-2 employees and 1099 workers, particularly in terms of taxation and benefits. Unlike W-2 employees, 1099 workers typically:

• Are hired for specific, temporary needs without a guaranteed ongoing commitment.
• Have autonomy regarding where, when, and how they work.
• Must provide their own equipment, tools, and supplies.
• Don't receive unemployment or health insurance, overtime or sick pay, or protection from minimum wage laws like exempt and nonexempt employees.
• Are responsible for paying their own federal, state, and local taxes, including self-employment taxes, and contributing to their retirement savings plans.

To determine the correct classification between a 1099 worker and a W-2 employee, consider the following factors:

Control over work

• W-2 employees: Employers directly manage how and when tasks are completed, providing detailed directives on work processes.
• 1099 workers: These individuals perform their duties independently, with minimal oversight, adhering solely to the terms outlined in their contracts.

Nature of relationship

• W-2 employees: Their roles are typically essential to the business’s day-to-day functions, which makes W-2 employment more stable and permanent than contractual work.
• 1099 workers: They fulfill specific, temporary needs, often moving from project to project, which highlights their contractual and transient relationship with the business.

Financial control

• W-2 employees: Employers pay them a set wage, provide all necessary tools, cover expenses such as travel, training, and supplies, and offer benefits and legal protections.
• 1099 workers: They manage their own finances, purchasing tools and covering all expenses. They handle profits, losses, and financial risks, without the benefits or protections W-2 employees receive.

Achieve W-2 compliance with Oyster

Effortlessly navigate the complexities of tax requirements and forms with Oyster. By streamlining the management of W-2 employees, Oyster ensures compliance with all legal obligations, allowing you to focus on your core business activities without the stress of administrative burdens.

Acting as an employer of record (EOR), Oyster simplifies the entire process, from handling tax documentation to ensuring accuracy in filings, so you can invest more time and resources into growing your business. 

With Oyster, not only do you benefit from an efficient and error-free payroll administration, but you also receive expert guidance to stay ahead of regulatory changes, keeping your business adaptable and compliant in a dynamic market environment.