An increasing number of Americans are earning a living by being a temp worker or a contractor. These are also known as freelancers and self-employed workers. Most of them will never see a W-2 form. Instead, they get a 1099.
A 1099 is a tax form created for anyone who has earned money as a contract or a temp worker.
Businesses send out a 1099 form to anyone they’ve paid during the previous year. The 1099 states the person’s total earnings from that year, who paid the earnings and any other relevant information.
While a W-2 also contains information about income and payroll taxes withheld over the year, a 1099 does not. Businesses that pay contract workers don’t withhold or pay any taxes on their behalf.
Both documents are the end-of-year earnings statement that workers use to file their income taxes. They tell you how much taxable income you earned and, as a result, how much money you need to report.
A 1099 is generated by anyone who paid a contract worker more than $600. Most people who get a W-2 will receive only one, while most people who get a 1099 will receive several because they work for multiple clients.
A 1099 is different from a W-2 because contractors pay their taxes differently than employees.
Income tax is technically a self-reported tax paid by everyone who earns income, in practice few people actively pay any taxes. Instead, employers estimate an employee’s likely tax burden based on their income and automatically withhold that amount from their paycheck and send it to the IRS.
But most people have more withheld from their paycheck than they actually owe in taxes. The result is that most people receive a refund on their taxes each year. This doesn’t apply to contract workers.
Someone who pays a contract worker does not withhold taxes, since it is considered a payment for services rather than income. As a result the 1099 has no tax payment information.
Instead the contractor has to pay their own taxes in full. This means not only paying taxes every April and/or making estimated payments to the IRS every three months.
Payroll taxes are separate from the income tax. They are taxes that apply to all income and are used to fund Medicare, Medicaid and Social Security.
Every dollar of earned income over $400 and under $132,900 is subject to the payroll tax, which is 15.3%. Of this, in an employer/employee relationship, each party pays half. As a result, a W-2 worker has 7.15% of each paycheck withheld for payroll taxes.
Contract workers, being self-employed, don’t have anyone to pay that other half of payroll taxes. As a result, they pay both halves. It comes to an intentional, designed-in 7.15% tax increase on everyone who works for themselves.
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March 2, 2020