1099 employees: What to know about being an independent contractor
Tips for the self-employed when it comes to IRS rules, your rights and filing your taxes.
Setting your own schedule and choosing to take on only the projects you want to may sound like a dream. And if it’s done right, it can be.
There can be ambiguity when you’re starting out fresh, though — with 1099s at the center of that mystery. In this guide, you’ll learn what a 1099 employee is, its affect on how you work and how to handle the often-dreaded tax filings associated with it.
What is a 1099 employee?
A 1099 employee is a worker that’s classified by an employer as an independent contractor — sometimes called freelancers, contractors or the self-employed.
However, there’s no clear definition for “1099 employee.” The 1099 refers to the IRS Form 1099-NEC that you may receive as an independent contractor for “nonemployee compensation.” Along with IRS Form 1099-MISC, these forms report to the IRS the taxable income you’ve earned as a nonemployee.
Independent contractors are different from those who are classified as employees in that you’re providing your services to the client, but the way you’re providing them is completely up to you. Independent contractors typically sign an agreement or contract that includes your working terms, but you may not have the same legal rights as an employee — including minimum and overtime wages.
Independent contractors and self-employed workers in an independent trade or profession, including:
- Airbnb hosts
- Freelance workers
- Real estate agents
- Self-employed workers
- Uber or Lyft drivers
What types of workers are classified as a 1099?
Businesses in the US are required by the IRS to classify workers as either employees or independent contractors. The right classification depends on the overall picture of how somebody performs their work.
Samantha Hawrylack, personal finance expert and cofounder of How To FIRE, offers additional insight: “Some key differences between a 1099 and a W2 employee are how they’re paid, the use of their own tools and equipment, benefits and insurance, length of time they’re set to be employed, and control over how work is completed and their schedule.” She adds, “1099 employees tend to have control over how the job is completed in regard to when and how they work, offering flexible schedules.”
Federal classification requirements
The IRS encourages employers to consider three main categories when determining whether a worker is an independent contractor:
- Behavioral control. Does the employer direct or control the working hours or equipment needed to complete assigned project?
- Financial control. Does the employer control the way which the worker is paid — for example, regular pay without an invoice — or reimburse for business expenses?
- Company relationship. Does the employer provide the worker with a pension, insurance coverage, paid time off or other protections?
State classification requirements
Every state has its own way of classifying independent contractors. Many use the ABC test to determine if an employee is an independent contractor:
- A: The worker is free from control and direction of the hiring entity.
- B: The worker performs work outside the employer’s scope of business
- C: The worker is customarily engaged in a similar trade, occupation or business similar to the hiring entity’s.
What to do if you think you’re misclassified
If you think your client is misclassifying your employee status — say, you’re acting more as an employee than an independent contractor — start by speaking with the company or employer about your relationship and whether a W-2 classification can better serve the relationship.
If your client isn’t receptive to the conversation, you can get the IRS involved by filing IRS Form SS-8 — Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding to request a determination.
This form offers a series of questions on your working relationship and how you’re treated by the client. The IRS will consider these details and reach out to your client or employer on your behalf before making an official decision on your worker classification. This decision may not be enough for the company to change your classification, unfortunately: It is not legally binding, which means the company may end up closing your contract and moving on without a satisfying resolution.
The benefits and drawbacks of a 1099
- You set your own schedule. Work whenever you see fit, so long as you meet your deadlines and obligations.
- Control the projects you take. If you aren’t happy with a client, you aren’t obligated to continue working with them.
- Work from anywhere. Work wherever you can render your services — at home, at a friend’s house, from the café down the road or halfway around the world.
- Tax obligations. With a 1099-MISC, you may have to deal with additional tax payments throughout the year or lump-sum prepayments on top of your usual filing.
- No benefits or protections. Health care and retirement aren’t built into your services like they are with more traditional employers.
Do I have to pay taxes as a 1099 employee?
Yes, you’re responsible for paying your own taxes. Your client won’t withhold federal or state taxes like they will for W-2 employees.
If your pay is $600 or more, you should receive Form 1099-MISC or 1099-NEC to report your income to the IRS from your client. Use the form to calculate your gross income on Schedule C.
Outside of the 1099-MISC, you may need to file your estimated taxes quarterly if you’ll pay more than $1,000 in taxes for the fiscal year.
All 1099 employees pay a 15.3% self-employment tax in two parts:
- 12.4% goes to Social Security
- 2.9% goes to Medicare
Your clients aren’t required to withhold these taxes from your paycheck, and so you must budget or set aside money to cover these costs.
Go to the IRS’s Self Employed Tax Center to learn more about taxes as a 1099 employee. A tax professional or financial adviser can help you understand whether you owe taxes or should file a 1099-MISC.How to do your taxes online
WATCH: How to file your taxes if you’re self-employed
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What is a 1099 form?
The 1099 form is what the IRS refers to as an “information return.” It’s a record that proves an company or entity other than your employer paid you money. For example, you may get one if your bank paid you interest or you earned income as a contract or freelance worker. Generally, the entity that paid you is responsible for sending a copy of your 1099 form to you in the mail.
Types of 1099 tax forms
The form is actually a series of documents that fit various reasons for your payments.
The two most common 1099 forms are the 1099-NEC and the 1099-MISC, which report nonemployee compensation. Other 1099 forms cover payments by way of bank dividends, real estate transactions and insurance payouts:
- 1099-A. Lists information about your home’s fair market value, the date of transfer and your existing loan balance after a home foreclosure. Use this information to determine if you’ve had a gain or loss on your property and owe any capital gains taxes.
- 1099-B. Lists gains or losses incurred from broker and barter exchanges during the year. Use this information to complete Schedule D when filing your taxes.
- 1099-C. If a lender cancels or forgives at least $600 of your outstanding debt, it’s considered taxable income in the eyes of the IRS — even if you receive no income at all. You must report any amount on this form as taxable income on your tax return.
- 1099-CAP. Lists cash or other property received as the result of changes in the capital structure of corporations for which you own stock.
- 1099-DIV. Lists dividends paid out from stocks, mutual funds or other investments you own. Dividends earned from a credit union are considered interest and instead are listed on Form 1099-INT.
- 1099-INT. Lists interest of $10 or more earned from a bank, credit union or other financial institution. Interest is considered taxable income that you report as earnings on your tax return.
- 1099-LTC. Lists long-term-care or accelerated death benefits. It’s typically sent out by the insurance company in charge of your benefits.
- 1099-MISC. Lists earnings of $600 or more earned from companies or businesses for which you’re an independent contract worker. You’re required to report earnings of $600 or more from each of your clients, even if they don’t send you this form.
- 1099-OID. Lists interest, profit and losses on long-term bonds, CDs, time deposits, notes or other financial securities bought at a discount.
- 1099-PATR. Lists dividends of $10 or more earned as a co-op member.
- 1099-Q. Lists distributions from a 529 college savings plan or Coverdell education savings plan (ESA). You shouldn’t need to report these distributions on your taxes unless they’re considered taxable income.
- 1099-R. The “R” in this form stands for retirement. It lists distributions from a retirement account, pension plan or annuity. Whether you need to report these distributions as income depends on the account they came from. For example, Roth IRAs have tax-free withdrawals, so you can file the form for record-keeping. If you withdrew money from a traditional IRA or 401(k), it will likely be reported as taxable income to claim on your tax return.
- 1099-S. Lists earnings from the sale of your house or other real estate.
- 1099-SA. Lists distributions from your health savings account (HSA). Distributions typically don’t count as taxable income, so you may be able to simply file the form for record-keeping.
Common 1099 expense deductions
Independent contractors may be eligible for deductions for business expenses, including:
- Home office expenses
- Work supplies
- Health insurance premiums
- Travel and meal expenses
- Car expenses and mileage
- Legal and professional services
- Fees, dues and subscriptions
- Continuing education
- Taxes and licenses
Talk with a tax or financial professional to learn about deductions or credits that can help minimize the taxes you owe.
How much should freelancers and independent contractors budget for taxes?
To budget for taxes owed as a self-employed worker, you’ll need to consider how much freelance income you expect to make.
Thomas J. Brock, a certified public accountant and certified financial analyst for Annuity, unravels two approaches to budgeting for self-employment taxes: “If you’re intent on maintaining a simplified approach, you could set aside 30% of your income for taxes. This approach is very conservative, but it guards against any unexpected cash flow surprises.”
Thirty percent may sound like a huge chunk of change, but you’re not only paying income tax. As a freelancer, you’re also responsible for self-employment tax, which covers Medicare and Social Security.
Brock advises, “The most comprehensive way for a self-employed professional to estimate his or her tax obligation is to use IRS Form 1040-ES.”
Brock adds that this can be cumbersome, so if you’re going at it alone, follow four steps:
- Pull your federal tax return from last year.
- Take the calendar year tax liability.
- Assuming this amount will approximate your obligation for the current year, divide it by four.
- Send quarterly payments to the IRS each quarter.
Filing estimated taxes
Depending on your self-employment income, you may need to send this budgeted money to the IRS every three months in the form of quarterly estimated payments. Doing so allows you to pay your taxes as you go, just as your employer would if you had a W-2 job. If you file your taxes at the end of the tax year and find out that you overpaid, you’ll get a refund.
You can find bank accounts designed for freelancers that help you set aside a portion of every paycheck for taxes so that you don’t accidentally spend the money. For example, the digital account Lili sets aside tax money, runs expense reports and pays you up to two days earlier than traditional banks.
If you’re required to pay quarterly taxes and miss a filing, you may pay a tax penalty of 0.05% of your balance due for each month after the deadline, with a cap of 0.25%
Talk with a tax or financial professional to learn whether paying quarterly is best for your freelance or independent contracting situation.
You can take advantage of setting your own price, working around your own schedule and controlling how you meet your obligations to your clients as an independent 1099 worker. But you’ll typically lose out on employee benefits like compensated time off, overtime and unemployment benefits, not to mention the responsibility of filing your own taxes throughout or at the end of the year.
- 2021 Schedule C (Form 1040), IRS
- Independent Contractor Defined, IRS
- How to FIRE, Samantha Hawrylack
- Independent Contractor (Self-Employed) or Employee?, IRS
- How Many 1099 Forms Are There?, Nolo
- Instructions for Forms 1099-MISC and 1099-NEC (2020), IRS
- Worker classification 101: Employee or independent contractor
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