In this day and age, defining a worker, an employer-employee relationship, and what employment terms are from a legal perspective has become more difficult.
This has led to increasing issues with payroll payments, certain information returns, unemployment insurance, and other concerns.
You may face this if you’re an independent contractor (sometimes called a 1099 contractor), a self-employed worker, or a small business owner.
A misclassified worker struggles to define their payroll tax, taxable income, and other liabilities imposed by the Internal Revenue Service (IRS).
So, what exactly do these terms mean? And what is the 1099 definition? How do you know if you’re a W-2 employee? What IRS form should you submit? We’ll go through all these questions, so hang on tight.
- 1099 Definition: What Does 1099 Mean?
- What Is the Difference Between 1099 and W-2?
- Does a 1099 Mean I Have to Pay Taxes?
- Who Needs a 1099 Form?
- Who Is Exempt From a 1099?
- How Does a 1099 Impact Your Taxes?
- Can I Avoid Paying Taxes on a 1099?
- Who Pays More Taxes: W-2 Employees or 1099 Contractors?
- Frequently Asked Questions
- Wrapping Up
1099 Definition: What Does 1099 Mean?
1099 is a number that refers to a tax form that records instances where a worker receives payment from someone other than an employer.
This can include services offered by an independent contractor or a self-employed person. Taxes for independent contractors vary and are harder to pinpoint.
What Is the Difference Between 1099 and W-2?
There’s a difference between 1099 and W-2 forms. The easiest way to tell is to know that a 1099 worker is an independent contractor, while the other worker is a W2 employee.
The 1099 form is issued to an independent contractor and any worker who doesn’t get paid through company payroll. Contrarily, a W-2 form is separate from the 1099 form and is issued to an employee on the company payroll.
The legal definition of a contractor is someone who does specific tasks according to the terms of a contract. They’re different from an employee in that they’re more independent and control how they perform their tasks.
As opposed to a traditional employee, they’re only held accountable for the outcome or result of a task, not how they go about it.
A contract worker also doesn’t get employee benefits or workers’ compensation, which means they have to handle insurance-related issues alone.
Does a 1099 Mean I Have to Pay Taxes?
No. A 1099 contractor does independent work according to their schedule and the market needs, making income out of their endeavors. Most often, there’s taxable income, while in other instances, there could be deductions that offset that income.
Alternatively, some or all of that income may be sheltered. This depends on how the income was generated and the assets that helped an independent contractor do so.
There are several types of 1099s, and the form depends on the income source and type. So, what are the common types of 1099 forms?
1. Form 1099-NEC
Form 1099-NEC is issued by companies to report any income they paid to a worker who isn’t an employee in their company.
So, if you’re an independent contractor, have a side gig, or freelance, you should receive 1099-NEC forms from your clients.
2. Form 1099-INT
You should receive a 1099-INT form if you make interest income from a brokerage, a bank, or other financial institutions. The minimum amount for that interest income is $10.
In 2022, the Internal Revenue Service (IRS) set a $20,000 minimum for goods and services. They had to be made thanks to business income or payments and to have been received through a third-party payment system or credit card. In that case, you’ll have to file a form 1099-K.
The volume is set at more than 200 transactions, but the IRS has lowered the threshold for the 2023 tax year to $600, according to this IRS publication.
4. Form 1099-Misc
The 1099-INT form is issued for any miscellaneous income that doesn’t fit other 1099 forms. Most commonly, this applies to income from awards and prizes.
Who Needs a 1099 Form?
There are various reasons why a worker may receive a 1099 form. It is expected if you’re a freelancer, independent contractor, or anyone classified in the gig economy as a worker.
In those cases, you must fill out a W-9 form at the beginning of the independent contractor relationship with your client, and you should receive a 1099-NEC from the client.
The 1099 form should have your Social Security number or taxpayer identification number. This means that the IRS will be aware that you’ve made money and, accordingly, will investigate your case if you don’t report that income on your tax return.
Who Is Exempt From a 1099?
Generally, an independent contractor who makes an income from doing business with a client should fill out the 1099 form. However, there are some instances where a 1099 may not be required:
- Employees: They receive W-2 forms to report wages, salaries, and other employee benefits.
- Business Expenses: Any payment made for the purchase of goods, materials, and merchandise.
- Qualified Exempt Organizations: These include religious organizations, government entities, and charitable organizations.
- A payment that’s below the reporting threshold: Any income below the $600 threshold, as long as the accumulative is less than the threshold throughout the tax year.
How Does a 1099 Impact Your Taxes?
If you receive a 1099 form, it will have a significant impact on how you pay your taxes. Firstly, you’ll pay self-employment taxes, including Social Security and Medicare taxes. Keep in mind that those taxes are higher than W-2 employee taxes.
Secondly, any income you receive and report on the 1099 form is considered taxable income. Accordingly, you’re required to report it on your tax return, and failing to do so might result in penalties and even legal consequences.
Can I Avoid Paying Taxes on a 1099?
No. If you have taxable income reported on the 1099 form, you should abide by that. The process makes the gig model work, and that’s why you shouldn’t try to mess with it.
Although you can’t avoid paying taxes, some common tax write-offs may aid in reducing the amounts you have to pay.
These include anything that you pay for to deliver your work. For example, phone bills, online fees for apps and services, car insurance payments, buying a new phone, having lunch with a coworker or client, and travel expenses.
Who Pays More Taxes: W-2 Employees or 1099 Contractors?
The answer to this question depends on the income tax that each has to pay, which is a proportion of their income.
If you’re an employee, you’ll have to pay 7.56% of your gross wage for employment taxes. This is half of the full amount (15.3%), which covers Social Security and Medicare taxes. Your employer pays the other half.
Contrarily, 1099 independent contractors must pay the 15.3% themselves, besides having to file estimated taxes quarterly and pay federal income tax as well as state taxes.
In other words, to break even, you should be making at least 7.56% more per hour as an independent contractor than you would as a full-time employee.
Frequently Asked Questions
Is It Better to Pay Workers as a W-2 or 1099?
The answer depends on various factors, such as legal obligations, financial considerations, and the nature of the working relationship.
If a worker is needed to perform a task sporadically, it would be better to treat them as independent contractors and pay them as 1099.
Contrarily, if a worker is expected to be on-call for their tasks at all times and prioritize your business needs, and you want to monitor how they do the work, you should consider making them an employee and paying them as a W-2.
What Happens If You Don’t File a 1099?
Failing to file 1099 forms or reporting inaccurate income may lead to penalties and fines, loss of deductions on business expenses, increased scrutiny of your tax returns, and legal consequences in the case of deliberate non-compliance.
After going through this comprehensive exploration of the 1099 definition, we hope you feel better equipped and more knowledgeable to navigate the complexities of being an independent contractor.
With this information in mind, you should be able to comply with Internal Revenue Service (IRS) tax regulations, minimize risks, and make informed financial decisions.
If you have any questions, let us know in the comments!