According to one recent study, about 36% of all workers in the United States are currently involved in the gig economy. In 2018, Americans spent literally billions of hours per week freelancing – a trend that shows absolutely no signs of slowing down, especially given the uncertainty created by the ongoing pandemic in the last year.
All of these people will receive not a W-2 to file their income taxes, but an IRS From 1099. The difference is enormous as far as the Internal Revenue Service is concerned, which is why if you’re interested in becoming a 1099 worker yourself there are a few key things you need to be aware of moving forward.
How 1099 Employees Differ From “Regular” Payroll Employees
The biggest difference between a 1099 employee and a payroll employee is that the former usually has full control over where, how and why they work. There is nobody in a leadership position telling them where to go or what to do. They can make their own hours and they are usually contracted out to perform specific tasks. Once those tasks are completed, the relationship with their client has ended. Because of this, freelancers usually have multiple clients that they’re doing work for at any one time.
In addition to determining their own rates, 1099 employees are not “employed” by any one particular person or entity.
Payroll employees, on the other hand, work for one company and are paid either hourly wages or a salary. They typically work directly from company offices and they’re entitled to certain benefits and protections that 1099 employees are not. Payroll employees usually get both unemployment and workers’ compensation insurance, for example.
But the biggest difference is that a payroll employee will have FICA taxes automatically deducted from their wages, while a 1099 employee will not.
The Tax Filing Requirements of 1099 Employees
One of the most important things that 1099 employees need to understand is that the IRS expects them to file quarterly estimated payments every year. The United States has always used a “pay-as-you-go” income tax system – that’s why in a traditional employment environment, money would be taken out of every paycheck to go to the IRS.
When you’re a 1099 employee you have no such luxury, which is why the IRS expects you to send them money four times per year. If you fail to do so, or if you fail to calculate the amount you should pay with each check correctly, you’ll be hit with an underpayment penalty. This will be equivalent to roughly 6% of the money you were expected to send for the period. It is possible to avoid this penalty if you qualify for an exemption, however.
Tax Rates for 1099 Employees
Acting as a freelance or 1099 employee means that you’ll need to pay self-employment taxes, which right now works out to approximately 15.3% of your total earnings. This is because you’ll be paying for the portion of Medicare and Social Security that would be taken care of by your employer in a more traditional employment situation. 12.3% of the above number will go to your Social Security tax, while the remaining 2.9% will go to your Medicare tax.
It’s also important to know that the Medicare portion of the tax will always apply, regardless of how much you earn. The Social Security side applies to all money you made up to $137,700 as of 2020. The good news is that you can deduct half of this tax as an expense when you file your taxes the following year.
What Taxes Do 1099 Employees Pay – The Lipsey & Associates Approach
At Lipsey & Associates, we understand that keeping track of your finances and financial obligations as a freelance employee can quickly feel like a full-time job – which is an issue, since you already have one of those monopolizing a lot of your time. But if you’re not careful, you could miss critical deductions that could save you quite a bit of money when tax time rolls around. You could also make a few common mistakes that could lead to some unfortunate negative attention from the IRS, too.
Whether you just need assistance handling your monthly budget or you want someone to come in and balance your books, the team at Lipsey & Associates has decades of combined experience and we’re ready to help in any way that we can. More than anything else, we want you to have the peace-of-mind that only comes with knowing your tax needs are taken care of thanks to a team of passionate accountants who have the skills and the training needed to handle your unique situation.
So if you still have any additional questions about 1099 employees and taxes, or if you’d just like to discuss your own needs with someone in a bit more detail, please don’t delay – contact Lipsey & Associates today.