If you report your wages on a 1099 form, your taxes will be very different than if you used a W-2 form. Independent contractors who provide services for a fee must fill out a 1099. Company employees who work regular hours and earn a regular paycheck must fill out a W-2. There are advantages and disadvantages to both types of employment. In either type of employment, it is important to know your responsibility come tax time.
If you get paid under a W-2 form, you only pay half of your Social Security taxes and Medicare taxes. The employer must pay the other half. This means you pay 5.65 percent of your wages for these taxes as of July 17, 2012. This percentage applies to the first $106,800 in annual income, and drops to 1.45 percent after that. Your employer automatically withholds these taxes from your paycheck. In addition, your employer will withhold federal, state and local taxes, as well as state unemployment insurance, depending on the laws where you live and work. When it comes time to file tax returns, W-2 employees will usually get either a refund or have to pay taxes, depending on factors such as earnings, deductions and exemptions.
If you use a 1099 form, you must pay self-employment tax. This means you pay all of the Social Security taxes and Medicare taxes, which comes to 13.3 percent of your earnings as of July 2012. After the first $106,800, you pay 2.9 percent. You pay a higher tax rate using a 1099 form vs. a W-2 form because there is no employer to pay for half of your Social Security and Medicare taxes. You must also pay federal, state and local taxes, as well as state unemployment insurance if you live in a state that requires you to pay these. You must pay all of these taxes when you file your returns. Some self-employed people pre-pay their taxes on a quarterly basis so they won't have one big payment on April 15.
Deductions for 1099 Workers vs. W-2 Workers
As a 1099 worker, you can take tax deductions that a regular employee cannot take. These include deductions for office supplies, travel expenses and other business-related purchases. You must have receipts to support your claims, and these expenses must be directly related to the operation of your business. Employees who use a W-2 form cannot deduct the same expenses as a 1099 worker, though they are usually reimbursed by their employers for these kinds of expenses. Self-employed workers do not get the full amount of their expenses back. Instead, they deduct the cost from their gross income, which might help lower their tax rate.
Internal Revenue Service Regulations
Many employers find it advantageous to use 1099 contractors for certain part-time jobs -- such as lawn or equipment maintenance -- because they don't have to match Social Security and Medicare taxes. However, the Internal Revenue Service has guidelines for those who must be treated as W-2 employee and those who can be treated as an independent contractor using a 1099 form. As a general rule, if your pay, work hours and duties are controlled by the company, you must be classified as a W-2 employee.
Kevin Johnston writes for Ameriprise Financial, the Rutgers University MBA Program and Evan Carmichael. He has written about business, marketing, finance, sales and investing for publications such as "The New York Daily News," "Business Age" and "Nation's Business." He is an instructional designer with credits for companies such as ADP, Standard and Poor's and Bank of America.