We'll start at the beginning: the paperwork you fill out when onboarding with a new client in preparation for your self employment tax. While staffed employees fill out a W-2 tax form, that's not the case for us. As an independent contractor, we get a 1099 instead.
There are many differences between an employee and an independent contractor. From a tax perspective, the primary difference between 1099 income and W2 income is that 1099 income must pay their own taxes that are normally withheld by an employer automatically when they pay a W2 employee a salary.
This is the biggest reason why many freelancers struggle to manage their tax obligations on their own because at a normal "job" the taxes are automatically taken care of by the employer's payroll provider when a W2 wage is paid.
Because of this extra financial burden, it's common for freelancers and other self-employed individuals to leverage software, accounting solutions, and tax accountants to help them manage their tax obligations. This is also why it's commonly understood that freelancers must set aside money for 1099 taxes every year.
If you've ever been a full-time or part-time employee at a company, you've filled out a W-2 form.
In this situation, I have to say: taxes are simpler. Money is automatically withheld from each paycheck and set aside for tax purposes. Not only that, but your employer actually pays half of your Social Security and Medicare contributions (ka-ching!). All you have to worry about is filing your personal income taxes each April.
But we're not here because we want to be salaried employees, are we? We're here because we want to break out into the wild world of freelancing and entrepreneurship. It's exciting, sure, but it's also a little more complicated when it comes to taxes.
When you take on an assignment as an independent consultant or freelance contractor that pays $600 or more, you'll need to fill out a 1099. Before 2021, most freelancers filled out a 1099-MISC. The 1099-NEC now is used for non-employee compensation.
First of all, remember: when you work for yourself, you're a business. You may be a company of one, but you're a company nonetheless. And as a solo operation, you act as both the employer and the employee. That means there's only one person around to withhold the money for all those various government taxes and contributions: you. And you need to make sure you pay those taxes on time.
Speaking of payments, there are two things to keep in mind when you make the move to 1099. First: in addition to personal income tax, you're required to calculate self-employment tax and pay your duty. Second: you'll most likely need to start making quarterly estimated payments.
Before your head starts spinning, let's stop and break these all down.
1099 Income is a self-employed independent contractor income with different 1099 benefits.
W2 Income is an employee's income with a regular wage, benefits, and employer-withheld taxes.
There may be some instances where you'll need to file a 1099 and W-2 in the same year.