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Transitioning from full-time employment at an established company to freelancing offers numerous benefits, including increased flexibility and autonomy. However, it also comes with important tax considerations as employment typically offers additional benefits that self employment and freelancing do not.
Employees are a distinct class of workers, as defined by the Internal Revenue Service, and receive W2 forms at the end of the year for reporting wages and calculating taxes. Employers of these workers have certain responsibilities to protect and support their employees, resulting in different benefits, tax treatments and actions on the part of the employee.
Freelancers, contractors and other self employed are typically not employed and have greater freedoms and responsibilities. They receive a different tax form, a 1099, each year from every organization where they provided services that year.
In this article, we will explore the distinctions between W2 and 1099 tax classifications and provide relevant insights for freelancers on the differences in tax treatments.
All income in the United States is subject to federal, state, and local taxes. As a W2 employee, these are typically calculated by your employer. This is beneficial as your employer is also responsible for withholding income taxes from your paycheck based on the allowances you elect. reporting your wages on Form W2 and paying those taxes to relevant federal, state and local agencies. That means a lot less work for you.
Get the benefits of a big company, while staying autonomous
As an employee, your employer also withholds and pays Social Security and Medicare taxes (FICA taxes) from your paycheck and also contributes a matching amount. This ensures you are covered under these programs and have access to future benefits.
Employees also have protections under the law. One such protection is that all full-time employees must receive the option to elect benefits such as health insurance, retirement plans, paid time off, and other perks. Not only do these employers typically get cheaper cost plans, with better coverage, but in many cases, employers even contribute to these benefits on behalf of employees.
When you work as a freelancer or independent contractor, you receive a Form 1099-MISC or Form 1099-NEC (starting in 2021). These are unique to self-employment and carry alternative benefits, tax considerations and responsibilities of the worker.
One of these differences is that, as a self-employed worker, you are responsible for paying both the employer and employee portions of FICA taxes (Social Security and Medicare taxes) through self-employment tax. These taxes contribute to your future Social Security and Medicare benefits.
And while self-employment brings a lot of autonomy, you’re still responsible for calculating, withholding and paying these taxes to cover your obligations. Typically, this is done through calculating and paying estimated quarterly taxes to cover their federal, state, and local tax obligations. Failure to pay estimated taxes may result in penalties and interest.
Similarly, as a freelancer, you are responsible for obtaining your own benefits, such as health insurance and retirement savings plans. These are typically available through state-sponsored exchange markets, self-employed health insurance and Individual Retirement Accounts (IRAs), but individuals sometimes find these options to be expensive and with limited coverage due to a lack of bargaining power with large providers.
On the flip side, freelancers are able to deduct legitimate business expenses related to their work, such as office supplies, equipment, software, travel expenses, and marketing costs and these deductions help offset taxable income. While it might reduce your obligations, it can at times make handling your taxes more complex and time-consuming.
Transitioning from a full-time job to freelancing is an exciting career move, but it requires a thorough understanding of the tax implications. Different tax treatments exist for W2 employees and 1099 freelancers. As a freelancer, you are responsible for self-employment taxes, estimated quarterly tax payments, and obtaining your own benefits. Prepare for the financial and administrative aspects of freelancing by finding a partner and tools like 8x5 that you can trust to help you with taxes, securing healthcare coverage, billing clients and keeping it all straight.
**Please note that the posting above is for informational purposes only and is NOT intended to be personal tax advice nor to be utilized as a substitute for any professional accounting services. The employees responsible for this post are not Certified Public Accountants. Any questions regarding tax treatments should be directed to a certified accountant. 8x5 Technologies LLC is not responsible for any actions users take based upon this website’s content.