Running payroll and filling out employer tax forms weren't probably the dreams that launched your small business. But, as an employer, both tasks are part of the routine that keeps your business running.
Hiring employees is a sign of business growth, and it’s actually quite exciting. Once you get used to all your new tax responsibilities, you can get back to feeling great about your expanding business. So, let’s knock out one of the big questions: “W-2 vs. W-4 — What’s the difference?”
Glad you asked! Here’s what small business owners need to know.
W-2 vs. W-4
Both W-2 and W-4 are forms the Internal Revenue Service (IRS) requires. The main difference between the two is who fills out the form. As the employer, you fill out a W-2 each year, while new employees fill out Form W-4 before they go on your payroll.
Form W-2 tells the IRS how much you paid your employees during the year and how much you withheld from their paychecks for tax purposes or other benefits, such as health care. For this reason, W-2 is also known as the Wage and Tax Statement.
Every year, you send a W-2 to the IRS and distribute a copy to each employee so they can use it to fill out their tax return.
Form W-4, on the other hand, is known as the Employee’s Withholding Certificate. Each employee fills it out. It tells you how much federal income tax you can withhold from that employee’s pay.
Consider providing it for employees during onboarding since you need it to set up their withholdings in your payroll. You can streamline tax withholding even more by using software like Hourly, which automatically deducts and pays your payroll taxes.
Before we dive in and take a closer look at each form, here’s a table that gives a quick comparison of the two.
We’ll start with the W-4 since it’s the form that needs to get filled out first. (You can’t start paying your employee until you have their W-4.)
What Information Is on the W-4?
IRS Form W-4 contains the information you need to withhold the right amount of money from your employee’s paycheck for federal income taxes.
When you hire a new employee, they will fill out this form and submit it to you as part of the onboarding process.
Here’s what each section on the form covers:
- Section 1—Personal information: Includes information you need to fill out their W-2, such as name, address, and tax filing status. This is also where you find the employee’s social security number. (Required)
- Section 2—Multiple jobs or spouse works: Completed by employees who have multiple jobs or are filing jointly with a spouse who also works. This ensures that each employer withholds the correct amount of taxes.
- Section 3—Claim dependents: This is where employees can note the number of dependents (such as children) they plan to claim on their tax return. It can be left blank if the employee has no dependents. The number of qualifying children under age 17 multiplied by $2000 goes in the first box, and the number of other dependents (such as stepchildren or siblings) gets multiplied by $500 and goes in the second box. Finally, add up the amounts in boxes 1 and 2, and enter that amount on line 3.
- Section 4—Adjustments: Employees who want you to adjust their withholding can indicate that here. More on that below.
- Section 5—Employee Signature: (Required)
Since sections 2, 3, and 4 don’t apply to everyone, your staff can leave any of these blank if they’re not relevant to them.
After the employee signature, there is a small section at the bottom of the W-4 labeled “Employer Only” for you to add your name, address, and employer identification number (EIN). You’ll also record the employee’s start date here.
Section 4 of the Employee’s Tax Withholding Certificate Form lets your employees reduce or increase the amount of money you withhold from their paycheck for federal income tax.
It’s divided into three optional adjustments: other income, deductions, and extra withholding.
In other income, employees can report passive income (such as dividends or retirement plans) from which they want you to withhold taxes. They can choose to have you withhold this amount from their paycheck to avoid putting a portion in savings themselves throughout the year.
For instance, your employee may have to pay end-of-year taxes on their investment dividends, but the companies that pay dividends don’t need to withhold taxes from those payments. Your employees may have you withhold more from their W-2 to make up this difference instead of taking out a portion of each dividend payment for taxes.
The deductions section lets employees reduce the amount of money withheld from their earnings. One common example of a deduction is student loan repayments. If an employee claims a deduction on their W-4, you’ll deduct less federal income tax from their paycheck and send them a higher net pay.
Finally, there’s the extra withholding amount. This section lets employees specify how much additional tax they want you to withhold for each pay period. The most common reason an employee would do this is if they have a side gig that might affect their personal income tax returns. And instead of saving money each month for taxes themselves, they might want you to withhold that amount from their paycheck automatically.
Ultimately, higher withholdings will either result in a bigger tax refund or a lower tax bill for your employee at the end of the year.
State W-4 Requirements
Form W-4 is used for federal income tax withholding. But, when you hire a new employee, you may also have to withhold state income taxes.
States That Use Their Own W-4
Some states have their own version of the W-4 form for withholding state income taxes. So, your employees will have to fill out the state and federal forms before they go on your payroll.
These states include:
- New Jersey
- New York
- North Carolina
- Rhode Island
- South Carolina
- West Virginia
*If your business is in Colorado or Delaware, employees can fill out the state form or just use the federal one for state tax withholding.
Why would they opt to choose two forms instead of just using one?
Well, the government got rid of withholding allowances on the 2020 W-4 Form to simplify the form. (The W-4 used to be known as the Employee’s Withholding Allowance Certificate).
Employees could take allowances that would reduce their taxable income. The number of allowances depended on certain tax situations, such as charitable donations or student loan interest.
On the federal form, this is now covered by the “deductions” line of Section 4 for optional adjustments. The states that accept or use the federal W-4 form recognize the amounts in your deductions section.
Some states, however, kept the allowances section and use it instead of deductions, which is why they use a separate tax form. Employees can reduce their state income tax by taking a withholding allowance, so they may choose to fill out both state and federal W-4s.
States That Use Info from the Federal Form
Some states only use the information from the Federal W-4 form. These include:
- New Mexico
- North Dakota
States That Don’t Require a W-4
If a state doesn’t have an income tax, you don’t have to worry about getting a state-level W-4 since there’ll be no state tax withholding. There are seven states that don’t have a personal income tax:
- New Hampshire
- Pennsylvania (imposes a flat income tax rate, no W-4 form needed)
- South Dakota
When Should Your Employees Submit Their W-4s?
When you run payroll, you need to deduct income taxes from your employees’ paychecks. And Form W-4 tells you how to calculate the withholding amount for a new employee. So, each new employee needs to fill out and submit it before they go on your payroll.
The easiest way to ensure you get this form on time is to provide it to new hires and include it as a step on your employee’s onboarding checklist.
Once you receive the form, fill out the bottom section labeled “Employers Only,” which includes your contact information, your employee’s start date, and your employer identification number (EIN).
Once that is complete, keep a copy in your records. That way, if you change payroll processing methods, you have this information for each employee.
Employees do not need to fill out a new W-4 form each year. However, if their financial situation changes, they can fill out a new form and submit it to you at any time. For instance, if an employee gets married or has a child, they can submit a new form to adjust their withholding.
Now that you know how the W-4 form is used, let’s dive into the form you need to fill out.
Form W-2 Explained
So, you receive your employee’s withholding form and add the employee to your payroll. How does the government know you’re actually withholding money for federal income tax?
Well, you report that information for each employee using IRS Form W-2.
Let’s look at the sections and information you need to fill out:
Boxes b, c, and d are for reporting employer information such as your name, address, and employer identification number (EIN).
In boxes a, e, and f, you’ll fill out your employee's contact information, including their social security number, name, and address.
Wages and Withholdings
Boxes 1–14 are used to report your employee’s gross pay for the tax year and how much money you withheld for taxes.
Instead of reporting the total amount of taxes you withheld, you will report the total amount for each type of tax. These include federal, state, and local taxes, as well as amounts deducted from the employee’s earnings for Social Security and Medicare taxes.
If you also withheld money from an employee’s wages for voluntary contributions, such as a retirement plan, you report that here too. You can refer to the IRS Instruction Form for more information on how to fill out each box.
Filling out this form each year for every employee can easily become time-consuming.
The good news is that you can use payroll software like Hourly to streamline the process. Hourly automatically generates a W-2 form for each employee and distributes an electronic copy to them.
When To File and Distribute Form W-2
Your W-2 forms are due to the IRS by Jan. 31 of the following year (or the next business day if the 31st happens to be on the weekend).
When you submit your W-2s to the government, you should also fill out and send the W-3, which is like a cover sheet for your other forms. It includes the total wages paid and taxes withheld for all employees.
The IRS also recommends that you e-file your documents to ensure they arrive on time.
Besides sending the forms to the government, you also need to send each employee a copy of their W-2 by the same deadline of Jan. 31. If you use payroll or accounting software, you can send electronic versions of the form to your staff.
You don’t need to send the W-3 to employees since they don’t need your business totals to do their taxes.
What About Independent Contractors?
All the information we’ve covered so far applies to employees. But what do you need to do if you hire an independent contractor? Do you also need to withhold taxes from them?
The good news is that you don’t. Independent contractors are self-employed, which means they are responsible for keeping track of their estimated tax payments.
However, you still need to report the amount you paid an independent contractor, so the IRS knows how much taxes they need to pay. You report their income on Form 1099-NEC, which is also due to the IRS and your freelancers by Jan. 31 of the next year. (This used to be reported on the 1099-MISC before the IRS brought back the 1099-NEC in 2020.)
Since you don’t withhold taxes from an independent contractor, you don’t need them to fill out a W-4 form. Instead, they should fill out and give you IRS Form W-9, which gives you the taxpayer information you need to fill out their 1099.
Once again, an independent contractor can forget to give you the W-9 form. So, we recommend asking each independent contractor to fill it out and send it to you right after they sign your work contract. Otherwise, you might find yourself chasing down these forms before the tax deadline.
Is It Better to Hire Employees or Independent Contractors?
So, which type of worker is best to hire? W-2 employees aren’t necessarily better than W-9s. Ultimately, it depends on your needs.
If you need a stable presence and have regular job responsibilities that need covering, a W-2 employee is probably best for you. However, these employees do require more admin work since you withhold their taxes each payday.
On the other hand, if you only need an employee for the length of a project (such as designing your website), hiring an independent contractor gives you more flexibility and less tax responsibility.
Either way, you have to report the total amount you paid each type of worker at the end of the year.
Keeping Track of Your Employer Tax Forms
Now that you know the difference between the W-2 and W-4 tax forms, you’re one step closer to becoming a pro at IRS tax documents. Eventually, it will all start to feel routine, and you can be the one explaining it to your friends who are just starting out their business ventures.
But for now, ensure you have your W-4 forms ready for employee onboarding so you can make sure your payroll taxes are accurate!