W-2 employees and 1099 contractors have completely different tax obligations for your business. Mixing them up or getting the math wrong creates problems that compound quickly, so here is how each one works.

For every W-2 employee, you withhold federal income tax based on the W-4 they submit. You also withhold Social Security at 6.2% and Medicare at 1.45% from their gross pay. In Arizona, state income tax withholding is based on a percentage the employee selects from a set of options on form A-4. That means both the employee and you need to fill out the right forms before the first paycheck goes out.

On top of what you withhold from the employee, you pay a matching employer share. That is another 6.2% for Social Security and 1.45% for Medicare, totaling 7.65% out of your pocket. Then there is FUTA (federal unemployment tax) at 6% on the first $7,000 of each employee’s annual wages, which typically drops to 0.6% after the Arizona state unemployment credit. Arizona SUTA rates vary based on your experience rating as an employer. New businesses usually start at a standard rate and it adjusts over time based on how many unemployment claims are filed against your account.

So if you are paying a W-2 employee $50,000 a year, your actual cost is that salary plus roughly $3,825 in employer FICA, plus FUTA and SUTA on the first $7,000, plus workers’ comp insurance. The real cost of an employee is always more than their wage.

For 1099 contractors, your tax obligation is essentially zero. You do not withhold anything from their pay. No federal income tax, no FICA, no state tax. They are responsible for their own self-employment taxes and quarterly estimated payments. Your only reporting requirement is issuing a 1099-NEC to any contractor you pay $600 or more during the calendar year, and filing copies with the IRS by January 31.

The critical rule is that one worker cannot be both W-2 and 1099 for the same type of work at your company. The IRS looks at the actual working relationship to determine classification. If you control when, where, and how someone does their work, they are likely an employee regardless of what you call them. Misclassifying employees as contractors to avoid payroll taxes is one of the most common audit triggers, and penalties include back taxes, interest, and fines.

Whether you are running construction job costing in Phoenix or managing a service business with a mix of staff and subs, getting this right from the start saves you from expensive corrections later. Track every payment to both categories carefully and make sure your books reflect the true employer cost for W-2 workers, not just their gross wages.

If the withholding calculations, deposit schedules, and quarterly filings feel like too much to manage alongside running your business, consider full-service payroll so someone handles the math, the deposits, and the compliance deadlines for you. The cost of professional payroll is almost always less than the penalties for getting it wrong.