Do you receive a W2 or a 1099 from your employer?
Depending on how you work, you may receive both.
But what’s the difference? How do you know what you’re supposed to be getting?
These are great questions, with fairly simple answers. Let’s dive in.
How You Pay Taxes
We all pay taxes, right? Taxes are one of the joys of life.
The goal is to pay your “fair” share, but not anymore than that.
You need to understand the tax code enough to know what your fair share is, but that doesn’t mean you have to know as much as Donald Trump about the whole thing. That’s borderline obsessive…
The main way most people pay their income tax is either through a Form W2 (for employees) or a Form 1099 (for independent contractors). The first puts a lot of the tax burden on the company you work for, while the second leaves the tax stuff up to you.
That’s the main difference: one is for employees, while one is for independent contractors, but how do you know which one is for you?
Which One is for You?
Your place of employment should help you figure that out by sending you one or the other.
Of course, when you got your job, they should’ve been pretty straightforward about how you are going to work, and how you are going to pay your taxes.
For example, with the new Gig Economy, the entire idea is that the workers are independent contractors. Hence the term “gig,” as in, you’re working a gig each time you go to work. It’s not necessarily full-time employment. The amount of time you work is up to you, and you only get paid for what you choose to work.
If you’re simply an employee at a company, your taxes should already be taken out of your checks, and all you have to do at the end of the year is plug your information into some tax software, or hand it over to a tax assistance company.
How W2s and 1099s Work
As I mentioned, when your working as an employer, your company deducts the amount of tax you owe from each paycheck. Of course, you still tell them how much to deduct based on your filing status and number of dependents, but whatever you tell them, that’s what is taken out of your check.
When you’re working as an independent contractor, you pay your own taxes. At the end of the year, the company you’re contracting for will give you a Form 1099 that shows how much they paid you throughout the year. Then you’ll figure out how much you owe in taxes, and pay it all at once.
Note: You must earn at least $600 as an independent contractor for the company to send you a 1099.
The best way to handle a 1099 is to always be putting some money back each month. That way when the tax bill comes due, you’re not caught off-guard. You know it’s coming, save some money.
Which One is Better?
As with most finance and tax questions, there’s not an easy answer to the “which one is better?” question.
It is true that 1099s mean you don’t just pay standard income tax, but you also pay self-employment tax. However, this is only relevant if you have a choice.
Some employers will actually ask you if you want to be paid as an employer or as an independent contractor. If that’s the case, know that your paycheck will be larger as an independent contractor, but you’ll owe more taxes at the end of the year due to the self-employment tax.
Social Security and Medicare will be higher (read: twice as much) when paying self-employment tax rates, so that’s something else to add to the mix.
Generally, you don’t have much of a say in the matter. If you work as an employee, you get a W2, if you work as an independent contractor, you get a 1099.
You can read about the difference between the W2 and the 1099 on the IRS website for updated numbers and figures.
What if You’re the Company?
Many companies are turning to independent contractors over employers.
The entire Gig Economy is based on independent contractors, and for good reason.
It makes a lot of sense to put the tax burden on the worker, because they’re the one paying the taxes.
There are plenty of tax breaks and ways to reduce what you pay. It’s up to you to figure all of that out, and it can be done. You can reduce your tax bill by knowing what you can deduct, knowing how to file, and/or hiring a professional.
It’s one less thing for the company to deal with, so expect a shift in the way taxes are handled over the coming years. Be prepared to do your own taxes.
Make sure you pay what you owe, but don’t pay too much.
Kalen Bruce is the founder of MoneyMiniBlog.com. He defies millennial laws by having no debt and four children.