Small Business Guide to Form W-2 and Form 1099-NEC – Part 1: Understanding the Critical Distinction

Managing payroll taxes can be a complex challenge for small businesses, especially with the rising number of independent contractors working alongside traditional employees. Balancing responsibilities such as withholding taxes and accurately reporting income on the correct tax forms requires careful attention.

Mistakes in classifying workers or handling tax forms like the W-2 for employees and 1099-NEC for independent contractors can lead to costly penalties and compliance issues. In this guide to filing payroll taxes for employers, we’ll explore the key differences between forms W-2 and 1099-NEC, highlight common pitfalls, and provide guidance to help small businesses navigate the intricacies of preparing and filing payroll tax forms.

Navigating the Difference: Employees vs. Independent Contractors

As an employer, you are responsible for withholding federal taxes, paying your share of federal, state, and local taxes, and reporting this information on tax Form W-2 for your employees. For independent contractors, you are required to report contractor income to the Internal Revenue Service (IRS) on tax Form 1099-NEC.

There are distinct differences between employees and independent contractors, and the working relationship determines their classification. Various federal agencies and some states have tests to help you determine how workers should be classified.

Following are highlights of the IRS’s common law rules that will help you determine how to classify individuals who perform work for your company. The goal is to assess the worker's degree of control and independence using three broad categories:

Behavioral Control

Behavioral control refers to the extent to which an employer has control over an individual's work product. Generally, a worker who is instructed on when, where, and how to work should be classified as an "employee." Behavioral controls include:

1. Type of Instructions Given: If you dictate when, where, and how to work, it indicates an employer-employee relationship.
2. Degree of Instruction: The more detailed the instructions, the greater the control you exert over a worker.
3. Evaluation Systems: If you use an evaluation system to measure work performance, this indicates “employee” status. An evaluation system that only measures results could indicate an independent contractor or employee status.
4. Training: If you provide job training, it indicates that you want the job done in a particular way and is strong evidence that the worker is an employee.

Financial Control

Financial control refers to factors that demonstrate the degree to which a business owner has the right to control the economic aspects of a worker's job. Financial controls include:

1. Significant Investment: An independent contractor typically has a substantial investment in the equipment they use while performing work for you. An employee does not.
2. Unreimbursed Expenses: Independent contractors are more likely to incur unreimbursed costs than employees.
3. Opportunity for Profit or Loss: If a worker has a significant investment in the tools and equipment used on the job and unreimbursed expenses, the opportunity to make or lose money increases, indicating an independent contractor status.
4. Services Available to the Market: An independent contractor is generally free to pursue other business opportunities.
5. Method of Payment: Employees are generally guaranteed a regular hourly or weekly wage amount. Independent contractors are usually paid a flat fee or on an hourly basis.

Type of Relationship

Type of relationship refers to factors that illustrate how a worker and business perceive their working relationship. These factors include:

1. Written Contracts: A written agreement that states the worker's classification is an employee or independent contractor is not sufficient to determine the status, the IRS says. Instead, the nature of how you work together determines whether the worker is your employee or an independent contractor.
2. Employee Benefits: Businesses typically do not provide employee benefits such as sick leave or health insurance to independent contractors. However, the absence of employee benefits alone does not mean the worker is an independent contractor.
3. Permanency of the Relationship: A worker who expects the relationship to continue indefinitely is generally considered an employee.
4. Services Provided as Key Activity of the Business: A worker who provides services integral to business operations, such as an attorney working for a law firm, is more likely to be directed by their employer (employee status).

Employers should avoid solely classifying a worker as an independent contractor based on any of the following reasons:

• A worker's request to be classified—or treated—as an independent contractor.
• The worker signs a contract.
• The worker carries out regular work assignments, such as a seasonal worker, on a sporadic or on-call basis.
• The worker is paid commission only.
• The worker does assignments for more than one company.

Impact of Employee Misclassification

Misclassifying workers can put your company at risk of violating various state and federal employment laws.

“If you treat an independent contractor as an employee, they can go to the IRS and say, ‘I was an employee, but they didn’t treat me that way,’” says G&A Partners’ Payroll Tax Director Thereasa Herald. “If the IRS determines that to be the case, your business can be held responsible for paying all back FICA taxes for that employee, as well as penalties and interest on back wages. They could also audit your business to see if you are doing the same to other independent contractors.”

Additionally, the Department of Labor says that you may be required “to pay liquidated damages in an amount equal to the back wages, as well as civil monetary penalties. Employers may also have to pay attorneys' fees associated with litigation.”

Common Mistakes You Might Be Making

Here are common mistakes your business may encounter when preparing and filing the 1099-NEC and W-2 payroll tax forms and tips on how to navigate or avoid them:

• Misclassifying workers. You may inadvertently treat a worker as an independent contractor when they should be classified as an employee (or vice versa).
  • G&A TIP: Become familiar with the IRS’s common law rules and apply them to everyone who conducts work for your business.
    
• Filing the wrong tax form. You cannot file a W-2 and 1099-NEC for an individual who performs the same set of duties in the same tax year. All payments for services rendered by an employee, regardless of the type of service, must be reported as wages on a W-2.
  • G&A TIP: Your business only needs to file a 1099-NEC if payments to an independent contractor met the defined threshold for the year, even though independent contractors must report all income on their tax return. In 2025, the threshold is $600. Beginning in 2026, this threshold increases to $2,000 and will be adjusted for inflation for calendar years in 2027 and beyond.
    
• Missing filing deadlines. Failing to provide W-2s to employees and 1099-NECs to independent contractors or not filing Copy A with the Social Security Administration (SSA) and IRS, respectively, by established deadlines can result in penalties.
  • G&A TIP: Prepare early and consult a payroll outsourcing expert to help manage processes and meet critical deadlines.
    
• Incorrectly calculating wages or nonemployee compensation. Entering the wrong total wages, tips, or compensation or providing incorrect federal, state, or local tax withholdings can result in the workers facing issues with their tax filing. In addition, you could face problems with your business' payroll tax liabilities to the IRS/SSA. Reconcile W-2 and 1099-NEC amounts with your records.
  • G&A TIP: Your business only needs to file a 1099-NEC if you paid an independent contractor $600 or more for the year, even though independent contractors must report all income on their tax return.
    
• Information errors. Failing to update information for employees and independent contractors, including names, addresses, and Social Security numbers, can result in an "Employer Correction Request," a written notification from the SSA that requests corrections and may trigger penalties.
  • G&A TIP: To avoid errors, verify employee information against their Social Security cards at the time of hire and request updates from employees annually.
    
• Failing to collect necessary W-9s from contractors. Businesses should require a completed Form W-9, "Request for Taxpayer Identification Number and Certification," from each independent contractor to get their correct Social Security number or Employer Identification number.
  • G&A TIP: Collect a completed and signed W-9 from every new contractor before you process their first payment.
    
• Overlooking state-specific reporting requirements. Some states have specific requirements related to W-2 and 1099-NEC filings and filing deadlines that may differ from federal mandates.
  
  • G&A TIP: Consult all state and local requirements applicable to your employees and independent contractors. Work with a payroll tax expert to stay on top of all requirements.

How G&A Partners Simplifies Your Tax and Payroll Obligations 

Managing your business’s payroll checklist can feel like a full-time job. By partnering with G&A’s experts, you gain a support team that manages all moving parts—including payroll tax filing, reporting, and more. This frees up time for you to focus on business strategy. 

Our payroll administration services include (but are not limited to)

• Payroll setup, reporting, and tax filing
• W-2 and 1099-NEC posting, printing, filing, and mailing
• Employment verification of current and past employees
• Employee and independent contractor classification
• Integrated time and attendance system

We also help ensure that your business meets federal and state tax filing and reporting requirements for any states where your employees and independent contractors work.

Engage G&A Partners for Seamless Tax Compliance

When you work with a PEO like G&A, you reduce the risk of employee misclassification or filing and reporting errors. You also gain access to a dedicated team of experts who know the HR industry’s ins and outs and can help you stay informed of employment-related laws and regulations.

Contact G&A Partners today for a free consultation on how we can streamline your payroll, HR, and tax compliance.