The question “employee or independent contractor?” may seem like a very simple question. However, if we ask, “W2 or 1099?” the answer is much more tricky and difficult. If you are currently trying to prepare everything you need to know about taxes right now, you should ask yourself whether you need a W2 or 1099 form. If you are an employee, some taxes have to be taken out, so you will receive the W2 form. On the other hand, if you are an independent contractor, you have to pay all of the taxes without deductions, and you will receive the 1099 form. There are W2 vs 1099 calculator tools available to help you compare the numbers. But what are actually the differences between the W2 form and the 1099 form?
What is the W2 Tax Form?
In short a W2 tax form is used to show the amount of taxes that are withheld from your paycheck for the year and is further used to file your federal and state taxes. You see, the IRS requires employers to report their employees’ wage and salary information on Form W2. This form also reports how much federal, state, and other taxes that are withheld from your paycheck. If you are an employee, it is extremely important to fill your Form W2 in order to prepare your tax return. To ensure that you receive the tax return in time, the IRS requires your employer to send you the Form W2 no later than the 31st of January.
You should only receive a W2 if you are an employee. If you are self-employed or an independent contractor, even though the work you do is similar to those of an employee, you should use the Form 1099 instead.
The W2 tax form is divided into several boxes which report different items that are related to your income. Box 1 has your annual wage and salary payments, whereas box 2 contains the amount of federal tax withheld from your paycheck. Other boxes are for the Medicare tax, Social Security taxes, and state income tax if applicable.
The Importance of Tax Withholding
If you use one of those W2 vs 1099 calculator tools, you may find that Form W2 will give you less income than Form 1099. This is the very reason why some people suddenly have the idea to use Form 1099 instead. However, once again, if you are an employee, you should use Form W2. If you are on Form W2, you won’t have to make periodic payments throughout the year by yourself.
Whenever your employer withholds amounts from your paychecks for federal taxes, these amounts are indeed remitted to the IRS throughout the year. The IRS actually requires everyone to make periodic payments throughout the year, but your employer takes care of this for you.
When you prepare for the federal tax return and calculate the total tax amount for the year you should subtract the withholding amount from your tax bill. Afterward the subtraction, you will know whether to expect some refund or make an additional payment. The same calculation is necessary for filing a state tax return.
What is the IRS 1099 Form?
The IRS 1099 form is a series of documents for information returns. This form reports income from self-employment earnings, government payments, interests and dividends, and others. There are several different 1099 forms for reporting various types of income other than the salary that your employer pays you. The entity that pays you is responsible for filling the appropriate 1099 form and sending it to you before the 31st of January.
Different 1099 Forms for Different Cases
Not all W2 vs 1099 calculator tools tell you which 1099 form to use, so let’s first take a look at the different types. In most cases, if you are self-employed or an independent contractor, Form 1099-MISC is what you need. You will receive a Form 1099-MISC from every client that has paid you at least $600 during the tax year. If you are a freelance writer or consultant, and you are hired by individuals or companies on a contract basis, you should report the income on Form 1099-MISC.
If you own a portfolio of mutual funds or stock investments, you may receive Form 1099-DIV to report your dividends and distributions that you have received during the tax year. Note that it does not include the income that you earn from stock sales. Instead, it considers the dividends, alias the payments from the corporations directly to the shareholders. On the other hand, if you have periodic interest payments and not dividends, you should use Form 1099-INT – this form is usually received from the banks where you have saving accounts.
Transactions may also increase your taxable income, even if you don’t receive a payment. Debt cancellations are considered as taxable income. For example, if your credit card company erases your outstanding balance, they will send you Form 1099-C to report the debt cancellation. Meanwhile, withdrawals from a retirement account should be reported through Form 1099-R. Finally, tax refund and unemployment compensation should be reported through Form 1099-G.
The Tax Amount
As explained above, some people are tempted to choose Form 1099 because W2 vs 1099 calculator tools show that Form 1099 will give you larger paychecks. However, you may not want to throw away your employee status after reading this article. Form W2 indeed reduces your paychecks, but that’s for tax withholding and your employer actually helps you pay one-half of the taxes.
Form 1099 does not reduce your paychecks because you have to pay your taxes by yourself regularly according to the periods. Besides adding more things to do, it also requires you to pay the taxes fully by yourself. So, you will actually owe higher taxes.
|Form W2||Form 1099|
|- Meant for an employee receiving wage or salary||- Meant for non-wage and non-salary income|
|- Used by employees||- Used by self-employed/independent contractors and for reporting other types of income|
|- Reduces the payment amount for tax withholding||- Does not have tax withholding|
|- Relatively lower taxes||- Higher taxes|
If you are an employee, you should choose Form W2. It will reduce the amount of your paycheck for tax withholding. However, your employer will take care of the periodic payments and pay one-half of the taxes. On the other hand, Form 1099 has several different types for income other than your wage or salary. If you are self-employed or an independent contractor, you should use Form 1099. This form will not reduce your income but you have to pay higher taxes.