Investment Glossary – 1099 Income
Have you ever worked as a Lyft or Uber driver? Or have you ever submitted an article to a publication and gotten paid for it? Did you ever work a temporary job? In a lot of these cases, the compensation that is paid to you is typically paid out in accordance with you being a contractor for the company you are doing work for, rather than as an employee. There are some key differences in the tax treatment of contractors and employees, with the most noticeable one being the tax form you receive at the end of the year once you have to file your taxes. Rather than receiving a W-2 form, contractors typically receive a 1099-MISC. This makes work done as a contractor frequently referred to as “1099 income.” The two terms are interchangeable.
In the case of 1099 income, you typically will get paid out the full value of the work you’ve completed, which means the taxes at both the federal and state level are not withheld from your paycheck. This means that you are often responsible for calculating how much income tax you owe, and making sure that you pay the required amount on time to all authorities you need to pay tax to. In some cases, such as New York City, that means paying city taxes as well. So while your paycheck from contracting work might look pretty big when you first receive it, you do have to take into account that any applicable taxes have not yet been deducted from that paycheck, and you need to put aside the proper amount so you can make payments when the time comes.
One of the key differences for contract workers compared with employees is the ability for contract workers to deduct certain work-related expenses that employees are not eligible to deduct. If you are treated as an employee, you may be entitled to take income tax deductions for items such as travel-related expenses and vehicle depreciation, but are often limited beyond some basic items you can deduct. The premise is that your employer is likely covering a lot of the other items, ranging from staples and paper, up to rent and utilities. Most employees don’t have to pay to connect their computer to the internet. But if you are set up as an independent contractor, you may be paying for additional costs that go into completing your duties, and as such, may be eligible for additional deductions. Picture the freelance graphic designer who needs to buy a new computer to do the work, as well as pay for electricity to power that computer from a home office. Those are the types of key differences in how the tax code views contractors and employees.
So 1099 income doesn’t refer to any magical amount of income that you are earning, but rather income earned as an independent contractor as opposed to as an employee. It is critical that you understand the key differences in taxation, including the fact that unlike employees, who often have taxes and other mandatory items deducted right out of their paycheck, contractors typically do not have taxes withheld from their pay. So make sure you are taking into account the tax burden you may have in the future if you are working as an independent contractor, as ignorance is not typically an accepted excuse if you fail to pay your taxes in a timely manner