The W-2 vs. 1099

There are two main ways in which you can earn income. It is important to understand which category you fall into because your work status impacts your taxes. Knowing your work status is essential for avoiding unexpected tax bills.

• A W-2 employee is hired directly by a company and earns a regular salary or hourly wage. The company automatically withholds federal and state income taxes from each paycheck. Employers also pay half of the FICA taxes.

W-2 employees have less flexibility but a steady income, benefits, and simpler tax filing.

• A 1099 contractor is a self-employed individual who provides services under an agreed-upon contract. These include freelancers, consultants, and many gig workers. Contractors receive a Form 1099-NEC instead of a W-2.

No taxes are withheld by employers from paychecks. Contractors must pay income taxes themselves and are responsible for both halves of FICA, totaling 15.3%, which is known as the “self-employment tax.”

If you are a contractor, you are technically not an employee. You need to set aside about 30% of every paycheck to cover both income and self-employment tax. Failing to do so may result in insufficient funds to pay taxes when they are due.