What are the differences between a W-2 and a 1099?

Question

For my entire career as a contractor, I have worked on a W-2 basis. Recently, I was offered a contractor job, but they will hire me only if I agree to a 1099 basis. As someone who has never dealt with this form of compensation/tax before, what are some things that I need to consider if I accept this job? For example, how much paperwork would I need to fill out for tax purposes (mileage, business lunches, business travel, etc.)? Also, if they do not withhold any taxes from my paycheck, then what percentage of my pay should I set aside for tax season?

Thank you.

Answer 1

If you work on 1099 basis you are considered self-employed. There's nothing special for federal tax purposes you need to do. You'll probably have to invoice your client on a regular basis to get paid. Technically you can deposit the funds in your personal account, but you'll find the bookkeeping much cleaner if you can find a free business checking account to run you consulting business from.

At the end of the year you will receive a 1099 from your client that includes the total payments made to you. You'll need to file Schedule C (or C-EZ) and Schedule SE with your return. List your income and expenses on Schedule C. The rules for what is a deductible expense can be found in IRS publication 535 (links below). You will have to pay self employment tax 15.3% on your net business income.

You don't "set aside" money for tax season. You need to make quarterly payments to the govt on form 1040-ES. Be sure to include your estimated self employment tax along with your estimated income tax when calculating your payments. The interest and penalty can be quite stiff if you forget to include this.

Most consultant have few deductions, usually only a couple of thousand a year unless you're making big retirement plan contributions. Use the IRS tax tables to help figure out the amount to pay quarterly. Remember to annualize the quarterly income to avoid an underpayment.

More information on estimated payments can be found on this IRA page http://www.irs.gov/businesses/small/article/0,,id=110413,00.html
and pub 505. Look into making your payments electronically with the Electronic Federal Tax Payment System, EFTPS.

You can reduce your taxable income with various Retirement plans (IRS pub 590) and health plans (pub 969). IRS pub 583 as good advice on record keeping.

You might also consider incorporating. It's a lot more complicated but you may end up paying considerably less in taxes. I recently wrote a page comparing W-2, 1099 & Incorporating for consultants available here: http://www.biztaxtalk.com/node/3

Hope this helps.
Linda :)

Answer 2

w-2 is what employees get. it's a paycheck where taxes are taken out every pay period.

1099 is like a small business. the great thing about 1099 is that you can deduct costs. You can write off car expenses, tools, office supplies, etc. The last thing you pay would be taxes. That's great!

for example. you make 1k on your w-2. taxes will be taken out first then you pay your expenses.

with a 1099, you make 1k then you deduct all your costs (write offs). After you deduct your cost ($300 for materials) you pay taxes on $700 instead of the full 1k. If done correctly, you can pay minimal self employment tax.

i would always prefer 1099 over w-2. No matter if you're an employer or a contractor.

Be careful tho because there are strict rules on who is considered an employee and who is a contractor.

Answer 3

W2's are Wage statements provided by an employer to an employee for the purpose of filing a tax return. A 1099 form is used to report other types of income, such as non-employee compensation, etc...

If you're getting paid on a 1099, then you're not an employee. You're an independent contractor and must account for your own payroll taxes and federal withholding. You'll have to pay quarterly estimated taxes and at the end of the year calculate via your tax return your Federal Tax liability as well as your Self Employment tax. You will be able to deduct expenses that you incur to generate income, so you won't be paying tax on every dollar you earn. Depending on your expenses, I'd suggest setting aside a minimum of 25% to cover taxes. Again you have to pay quarterly estimated taxes, you'll need to read this irs publication:

Publication 1779 Employee Independent Contractor Brochure

Answer 4

I had my own business for 10 years under older tax laws, but the information organization is the same. Pub 17 from the IRS is a wealth of info, and easy to read. The W-2 you used to use kept track of income, SS, Medicare, and Workman's comp. Your old records will provide the percentages you can set aside when you work from a 1099, which deducts none of these things. An outfit called Dome publications has a note book by week, month and year that you can use as a pattern for record keeping. Keep track of everything you can get a receipt for, and a notebook for things you don't. Sounds tricky, but the habit comes quickly when you're dealing with a tax rate of 20-35% on net income. Don't forget to set aside the 15% or so for SS, and you're entitled to a private IRA also. The legal deductions are numerous and worth learning, but don't suppress your earnings so much that you damage your SS earnings history. You may need SS in the future, if its still there. Your call.

Answer 5

Can't answer the question because you have been a contractor all your career--means you were a private contractor. A private contractor is responsible for paying full Social Security Taxes (15%), not covered by pension. In short W-2 (IRS with-holding taxes) means you are an employee with a firm with some rights; 1099 ( No IRS with-holding YOU must file Estimated taxes quarterly) means you are self employed with no rights. Send request to IRS for a 1099 Publication

Answer 6

You'll have to take out your own taxes, matching Medicare, matching Social Security. Also, depending on how they want to work the 1099, you'll have to give your employer a "Bill" for services. That is, you'll have to invoice them (instead as a W-2, your employer did that) You'll have to have extra (like 90 days) worth of $$ available to float while the company pays you.

The benefit of this is that you can deduct much more and your per hour rate is higher (I would start with your W-2 rate + 30%)

good luck

Answer 7

you will have to file along with your form 1040 a 1040 schedule C and a 1040 schedule SE. On sch. C you will declare your profit or loss and the expenses you mention such as mileage. The sch. SE is for self employment tax for social security. You will have to file form 1040-ES quarterly for your estimated tax to avoid a penalty. This amount would be according to your income. I can take a guess for you , not knowing the income. I think 20% of your income would probably cover it.

Answer 8

W-2 if filled out by an employer and a copy is sent to IRS - which shows salary and payroll deductions. 1099 misc - is also sent to the IRS - but only shows gross pay - he does not take out any taxes - this is your responsbility to pay your own taxes!@

Answer 9

Why don't you go read the messages the last time you asked this question.