If you’re a 1099 worker, your tax life is very different than that of employees. It’s vitally important to understand how to file your taxes when you’re a 1099 worker, or you can end up in big trouble with the IRS.
You’re An Independent Contractor, Not an Employee
1099 workers are independent contractors, not employees of their clients or customers. Independent contractors are treated very differently from employees for tax purposes. For one thing, no taxes are withheld from your pay. In contrast, employers must withhold federal and state income tax, as well as Social Security and Medicare tax, from their employees’ pay and send it the IRS and state tax agencies.
Instead of having their tax withheld, 1099 workers must pay estimated taxes four times per year directly to the IRS and their state tax agency (see below). 1099 workers can deduct any necessary expenses related to their business. Employee’s work-related deductions are severely limited.
Some deductions available to 1099 workers may not be taken by employees.1099 workers ordinarily file more complex tax returns than employees because they must list their business income and expenses in a separate tax schedule.
What Federal Taxes Do 1099 Workers Have To Pay?
Your taxes will consist of income taxes, and Social Security and Medicare taxes (also called self-employment taxes when paid by 1099 workers).
The vast majority of 1099 workers are sole proprietors. A sole proprietorship is a one-owner business. The business owner (proprietor) personally owns all of the assets of the business and controls its operation. If you’re running a one-person business and haven’t incorporated or formed a limited liability company, you’re automatically a sole proprietor.
When you’re a sole proprietor, you and your business are one and the same for tax purposes. Businesses that are sole proprietorships don’t pay taxes or file tax returns directly. Instead, you must report the income you earn or losses you incur on your own personal tax return, IRS Form 1040, which is due each year by April 15. If you earn a profit, the money is added to any other income you have-for example, interest income or your spouse’s income if you’re married and file a joint tax return-and that total is taxed. If you incur a loss, you can use it to offset income from other sources.
How To Determine If Your Business Is Profitable
Although you are taxed on your total income regardless of its source, the IRS does want to know about the profitability of your business. To show whether you have a profit or loss from your sole proprietorship, you must file IRS Schedule C, Profit or Loss From Business, with your tax return. On this form you list all your business income and deductible expenses.
Sole proprietors are not employees of their proprietorships; they are business owners. Their businesses don’t pay payroll taxes on a sole proprietor’s income or withhold income tax from their compensation. Yet, sole proprietors do have to pay self-employment taxes.
This includes Social Security and Medicare taxes on net self-employment income. The Social Security tax is a flat 12.4 percent tax on net self-employment income up to an annual ceiling that is adjusted for inflation each year. In 2017, the ceiling was $127,200 in net self-employment income. There are two Medicare tax rates: a 2.9 percent tax up to an annual ceiling of $200,000 for single taxpayers and $250,000 for married couples who are filing jointly. All income above the ceiling is taxed at a 3.8 percent rate.
Note that 1099 workers and employees are each entitled to Social Security and Medicare benefits, but independent contractors must pay twice as much Social Security and Medicare taxes as do employees. This is because employers must pay 50 percent of such taxes on their employees’ behalf.
Your business income and self-employment taxes must be prepaid four times a year in the form of estimated taxes (see below).
State Taxes for 1099 Workers
All states except Alaska, Florida, Nevada, South Dakota, Texas, Washington, and Wyoming impose income taxes on the self-employed. New Hampshire and Tennessee impose income taxes on dividend and interest income only. Most states charge a percentage of the income shown on your federal income tax return.
In most states, you have to prepay your state income taxes during the year in the form of estimated taxes. These are usually paid at the same time you pay your federal estimated taxes. You’ll also have to file an annual state income tax return with your state tax department.
Tax Deductions for 1099 Workers
You only need to pay income and self-employment tax on your net business income. This is the income you have left over after you subtract all of your deductible business expenses from the total amount you earned from your design business during the year.
Business deductions are quite valuable. If you’re in the 25 percent income tax bracket, each $100 in deductions saves you $25 in income tax. It will also usually save you about $15 in self-employment taxes as well.
You may deduct any expense that is:
- directly related to your business
- ordinary and necessary, and
- not lavish or extravagant under the circumstances.
What Are Some Common Deductions for 1099 Workers?
- outside and home office expenses
- local travel expenses
- business travel expenses
- equipment and other long-term property
- software and online service subscriptions
- promotional expenses
- legal and professional services
- business-related meals and entertainment, and
- business start-up expenses.
How To Pay Estimated Taxes
1099 workers don’t have any tax withheld from their pay by their clients. Instead, they must make four estimated tax payments to the IRS each year. If you fail to pay estimated tax, you could have a whopping tax bill due on April 15 and you’ll also have to pay a penalty to the IRS.
When Are Estimated Taxes Due?
The due dates for estimated tax payments are shown in the following chart.
|Income Received for the Period||Estimated Tax Due Date|
|Jan. 1 through March 31||April 18|
|April 1 through May 31||June 15|
|June 1 through Aug. 31||Sept. 15|
|Sept. 1 through Dec. 31||Jan. 15 of the following year|
Other Tax Information To Know
You don’t have to start making payments for any given year until you actually earn income. You can pay online or by postal mail.
Ideally, the four estimated tax payments you make each year will add up to your tax liability for the year. However, if your income varies substantially from year to year, it can be hard to estimate how much you must pay during the year. Fortunately, there is a way to avoid having to estimate how much you’ll make. No matter what your income for the current year turns out to be, you won’t have to pay any penalties if the estimated tax you pay is at least the smaller of:
- 90 percent of your total tax due for the current year, or
- 100 percent of the tax you paid the previous year or 110 percent if you’re a high-income taxpayer (those with adjusted gross incomes of more than $150,000 or $75,000 for married couples filing separate returns).
Many independent contractors establish separate bank accounts to save up for taxes into which they deposit a portion of each payment they receive from clients. This gives them some assurance that they’ll have enough money to pay their taxes when they are due.
How Do 1099 Workers Report Wages?
When you’re a 1099 worker, you don’t have an employer who will file IRS Form W-2 reporting to the IRS how much compensation you were paid during the year. However, this doesn’t mean the IRS won’t have at least some idea of how much you were paid by your clients or customers.
If a client pays you $600 or more over the course of the calendar year by check, direct deposit to your bank, or cash, then the client must complete and file IRS Form 1099-MISC to report those payments. The 1099-MISC must be filed by January 31 with the IRS , your state tax agency, and you. You need not file the 1099s you receive with our tax return. Just keep them with your tax records.
Only payments made by check, cash, or direct deposit need be reported on Form 1099-MISC by your clients. Your clients have no duty to report payments they make to you electronically-for example, by PayPal. Electronic payments need to be reported to the IRS by the payment processor only if you are paid over $20,000 and have more than 200 transactions during the calendar year.
Because 1099 reporting rules don’t cover all types of payments 1099 workers receive, the IRS may have no record of some of the income you earned during the year. However, note carefully that you are required to report on your tax return all the income you earn as a 1099 worker, even if your client or customer doesn’t report it to the IRS on Form 1099.