Earnings other than normal employment are reported with IRS Form 1099

Earnings are reported either as normal employment income on IRS Form W-2 or as contractor payments on IRS Form 1099, but not both.

What’s the difference?

The IRS provides guidance to determine whether a person is an employee or contractor. The organization’s role in income taxes is different between the two, and contractors can deduct costs that employees cannot when determining their taxable income.

Employees and the W-2

Organizations (e.g., companies, agencies, non-profits, etc.) are required to withhold taxes from earnings paid to employees and to submit those withholdings to the IRS. The organization also pays an employer’s share of the taxes.

Employees file an annual tax return that compares their withholdings to calculated taxes based on taxable earnings and personal deductions. In most cases, employees receive a small refund.

Contractors and the 1099

The IRS’ general rule is that an individual is an independent contractor if the organization has the right to control or direct only the result of the work and not what will be done and how it will be done.

The organization is not required to withhold taxes from contractor payments and does not pay an employer’s share of income taxes. Rather, the organization pays the independent contractor just as they would pay a vendor invoice, like a utility bill or a cleaning service.

Independent contractors are self-employed and must pay a self-employment tax. In essence, the 1099 contractor pays both the employee’s and employer’s share of the taxes.

The independent contractor is responsible for making quarterly payments of their estimated tax liability, or face penalties.

On the upside for contractors, any costs related to the delivery of those services are deductible for calculating their tax liability. Deductions available to contractors and not employees include home office and related utilities and internet costs, computers, business cards, cleaning services, mileage, tolls, parking, child care, supplies, and any costs you can relate to the services you provide. For example, a fitness instructor working as a contractor will be able to deduct their fitness clothing, but working as a W-2 employee they cannot.