What Are 1099 Employees?
1099 employees, also known as independent contractors, are self-employed individuals who provide services to a company on a contractual basis rather than being employed directly. “1099” refers to a tax form—in the United States, traditional employees receive a W-2 form that reports annual wages, while independent contractors receive a 1099-NEC form that documents the income they earned from each client or company over the tax year.
1099 workers operate under their own business structure and name. They are responsible for managing their own taxes, including paying self-employment tax and making quarterly estimated tax payments to the IRS.
The flexibility of being an independent contractor comes with the obligation to handle one’s own tax filings and payments, which differ from those of traditional employees. This includes keeping track of earnings from each client, calculating taxes owed, and meeting different filing deadlines.
This is part of a series of articles about 1099 employee.
Which Taxes Do 1099 Employees Need to Pay?
1099 workers are responsible for paying the following taxes.
Self-Employment Tax
Self-employment tax is a mandatory contribution that 1099 workers must make to cover Social Security and Medicare. The current self-employment tax rate stands at 15.3%, which is divided into two parts: 12.4% for Social Security and 2.9% for Medicare. This rate applies to the net earnings of the independent contractor after business expenses have been deducted.
Independent contractors are responsible for both the employer and employee portions of these taxes, paying double what traditional employees contribute for Social Security and Medicare. However, to ease this financial burden, the IRS allows independent contractors to deduct half of their self-employment tax contribution when calculating their adjusted gross income on their personal tax return.
Federal Income Tax
Federal income tax is another obligation for 1099 employees, calculated on the net profit of their independent contracting business. This involves determining the total income received from all clients after subtracting allowable business expenses. The resulting net profit is then subject to federal income tax rates, which vary based on the contractor’s taxable income and filing status.
As of mid-2024, these are federal tax rates in the United States:
Unlike traditional employees, whose federal income taxes are withheld from each paycheck by their employer, independent contractors must calculate their tax liability and make quarterly estimated tax payments to the IRS. Failure to make these payments, or underestimating the amount due, can result in penalties and interest charges from the IRS.
State Income Tax
Independent contractors must also consider state income taxes in addition to federal obligations. The specifics of state income tax vary depending on the contractor’s location, as each state has its own tax rates and rules. While some states have a flat tax rate applicable to all income levels, others use progressive tax rates that increase with higher income brackets.
For 1099 employees, paying state income tax involves calculating the net profit from their contracting business, similar to federal taxes, and then applying the relevant state tax rate. Not all states impose an income tax.
How Does an Independent Contractor Pay Taxes?
1099 workers must conduct the following activities to ensure they fulfill their tax obligations.
1. Reporting Self-Employment Income
Independent contractors report their business income and expenses on Schedule C, which is filed with their personal tax return. This form calculates the net profit or loss from their business activities, which is then subject to income taxes. To accurately fill out Schedule C, contractors must keep records of all business-related income and expenses throughout the tax year.
The net profit derived from Schedule C is also used to calculate self-employment taxes due on Schedule SE. These figures help determine the total tax liability of an independent contractor.
2. Claiming Deductions
Independent contractors can significantly reduce their taxable income through deductions for business expenses. Common deductions include home office expenses, supplies, equipment, travel costs related to business, and professional services fees. These deductions must be ordinary and necessary for the operation of the business. Careful record-keeping is essential to prove these expenses in case of an IRS audit.
The Tax Cuts and Jobs Act introduced the Qualified Business Income Deduction, allowing eligible independent contractors to deduct up to 20% of their net business income. This deduction can provide tax savings and lower the effective tax rate on business income. However, there are limitations based on income levels and types of businesses that qualify.
3. Paying Self-Employment Taxes
Self-employment taxes are mandated for individuals who work as independent contractors, including contributions to Social Security and Medicare. As mentioned above, the rate is set at 15.3%, split between 12.4% for Social Security and 2.9% for Medicare, applied to the net earnings after deducting business expenses.
4. Making Quarterly Estimated Tax Payments
Independent contractors are required to make quarterly estimated tax payments to the IRS, covering both income and self-employment taxes. This system ensures taxes are paid as income is earned throughout the year, aligning with the pay-as-you-go tax system. Contractors estimate their total annual tax liability and divide this amount by four to determine their quarterly payment.
These payments are due in April, June, September, and January of the following year. Failure to make these payments or underestimating the amount can result in penalties. Using previous years’ tax returns as a baseline can aid in these calculations, but adjustments should be made for any anticipated changes in income or deductible expenses.
5. Submitting 1099-MISC
The 1099-MISC form documents the income contractors receive from clients or companies throughout the tax year. Unlike traditional employees who receive a W-2 form detailing their wages, independent contractors get a 1099-MISC from each client who pays them $600 or more during the year. This form serves as a record of the payment received and is essential for accurately reporting annual income on tax returns.
To comply with IRS requirements, independent contractors must report all income listed on their 1099-MISC forms, along with any additional income that might not have been documented through such forms. It’s important to keep detailed records of all payments received, as any income earned, regardless of whether it reaches the $600 threshold or not, must be included when filing taxes.
1099 Worker Taxes: Best Practices for Employers
Here are some best practices that employers should be aware of when hiring independent contractors.
1. Perform Correct Employee Classification
Correctly classifying workers as either employees or independent contractors is crucial for tax compliance and financial planning. The IRS criteria focus on the degree of control and independence in the relationship, considering factors such as behavioral control, financial control, and the relationship’s nature.
Misclassification can result in penalties, including back taxes and fines. Employers should conduct a thorough review of their working arrangements using IRS guidelines to ensure accurate classification. Tools like the IRS Form SS-8 can help if there’s uncertainty.
2. Keep Accurate Records
Accurate record-keeping involves maintaining detailed records of all income received, as well as tracking business-related expenses that can be deducted. By keeping precise and comprehensive records, contractors and hiring organizations can ensure they report all income and expenses accurately and maximize the workers’ eligible deductions.
Well-organized financial records are also crucial in the event of an IRS audit. Both employers and independent contractors should retain receipts, bank statements, invoices, and payment records to substantiate any reported income and claimed deductions. A systematic approach to record-keeping, possibly with accounting software or spreadsheets, simplifies this process.
3. Issue 1099-NEC Forms
Employers are required to issue Form 1099-NEC to every independent contractor who has been paid $600 or more during the tax year for services provided. This form must be sent to the contractor by January 31 of the following year, ensuring that both parties have the necessary documentation for tax purposes.
This form is the primary method for reporting non-employee compensation to both the contractor and the IRS. Issuing 1099-NEC forms involves accurately compiling payment records for each contractor. Employers should track payments throughout the year to enable this process.
Employers should also obtain a completed Form W-9 from every contractor before work begins, which will provide the needed information, such as their taxpayer identification number (TIN) or Social Security Number (SSN), to accurately prepare and issue the 1099-NEC forms.
5. Use Software for Management and Reporting
Incorporating software solutions to manage and report taxes can simplify the process for both independent contractors and employers. These tools offer functionalities like income tracking, expense categorization, and tax calculation, automating many of the manual tasks associated with tax preparation.
For independent contractors, this means more accurate record-keeping and easier identification of deductible expenses, leading to potentially lower taxable incomes. For employers, tax management software simplifies the process of issuing 1099-NEC forms by accurately tracking payments to contractors throughout the year.
Related content: Read our guide to 1099 rules for employers
Managing 1099 Employee Taxes and Compliance with Fiverr Enterprise
Fiverr Enterprise improves and automates the process of reporting and filing 1099 forms through streamlined workflows. We verify all information while your freelancers are still potential candidates, making sure that you have all the necessary details and data on file to complete all documentation when filing season rolls around.
We help you to maintain thorough records by continuously checking for compliance and changes to freelancer status, so you’re never left stuck when it’s time to get those forms to the IRS and to your freelancers themselves.
No need to mark your calendars, as Fiverr Enterprise will stay up to date on deadlines, even if they move due to weekends or holidays, and ensure that all the right forms are submitted accurately and on time, so you have zero chance of penalties.
For the majority of businesses, e-filing will be the best practice, and Fiverr Enterprise can help you get set up so that reporting is a process that happens seamlessly and automatically in the background.
Learn more about Fiverr Enterprise when you schedule a 30-min call with one of our workforce experts today!