A 1099 contractor, also known as an independent contractor, is a classification assigned to certain U.S. workers. The "1099" reference identifies the tax form that businesses must file with the Internal Revenue Service (IRS), and it relieves the employer from the responsibility of withholding taxes from the individual's paychecks. Although independent contractors provide a service to an organization, they are not considered employees of the company. This shifts the burden of ensuring that income taxes are paid each year from the employer to the workers, provided that these individuals earn at least $600 US Dollars (USD) per year and are U.S. residents or citizens.
Which Taxes Must Be Paid?
As an independent contractor, an individual is basically self-employed. In addition to any state and federal income taxes, people who earn at least $400 US Dollars (USD) each year must pay self-employment taxes to help finance Social Security for retirement and Medicare for health-related benefits. The charge for these taxes varies, depending on person's income, but it's usually a percentage of what he or she earns.
How and When Are Taxes Paid?
Considering that federal and state income taxes aren't automatically being deducted each pay period, the contractor must decide how to satisfy his tax obligation. In most cases, the person is required to make quarterly estimated payments based on the previous year's income to the IRS to avoid being hit with penalties and a high tax liability each year. To make the most of the tax money, an individual might take a portion of this amount out of his or her pay each month and deposit the money into a savings account until the taxes are due, allowing him or her to earn interest on the funds.
Quarterly estimated tax payments are typically due on 15 April, 15 June, 15 September, and 15 January of the following year. As with those who earn income as an employee, people who are self-employed must file their taxes and pay any additional money due by 15 April of the year after the money was earned.
If an independent contractor is one of the individuals filing a joint tax return — especially if the other individual is a full-time employee of a company — the couple could handle payments a little differently. If the person who is filing as an employee has overpaid his or her taxes throughout the year, that money, which would normally be returned as a tax refund, might instead need to be applied to any amount owed by the 1099 contractor. Some couples have actually worked this to their advantage, with the regular employee dropping his or her deductions so that a larger amount of tax is withheld than would normally be correct. The overpayment is then applied to the freelancer’s tax obligations.
What Are the Pros and Cons?
To offset some of the tax expense, someone who is self-employed can often take advantage of certain deductions that aren't necessarily available to the average employee. For instance, he may be able to write off a home office that's used exclusively for work, business supplies, and traveling expenses, in addition to work-related lunches, when appropriate. Doing this, though, typically means many more forms to file at the end of each tax year.
It's important that the individual be able to accurately document all of these expenses. Because some of these deductions are pretty easy to falsify — a home office is supposed to be used exclusively for business purposes, for example — people who file certain tax forms are more likely to be audited than others. Filling out all tax forms honestly and keeping good, accurate records is the best way for people to be prepared should the IRS ask questions.
In addition, there are some taxes that a 1099 contractor isn't required to pay. Most importantly, these workers aren't required to pay unemployment taxes, which are taxes paid by an employer on behalf of its employees, and are not deducted from the employees' paychecks. Since contractors aren't employees, they don't pay this money, which seems like a benefit that would puts more cash in the individual's pocket. This also means, however, that the individual is not entitled to collect unemployment benefits if he or she loses a contract or cannot find work.