Not all workers are created equally, at least not at tax time. An independent contractor receives Form 1099-Misc showing what income he took in during the year, while an employee gets a W-2. The difference goes far beyond simple forms, however, and the Internal Revenue Service has a host of rules for determining which category a worker falls into.
The Difference Between an Independent Contractor and an Employee
If the person or company you work for controls how and when you do your job, you're most likely an employee. You report to work for specified periods and address assigned tasks. You're paid on your employer's schedule; you don't submit invoices for your time after you've completed a job. But even the IRS admits that these rules aren't hard and fast. It advises that you should look at your overall relationship. If you can't decide which you are, you can file Form SS-8 with the IRS, and it will make a determination for you.
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Under most circumstances, the IRS considers commissions to be supplemental income if you also earn salary or wages for your job. You're an employee and you'll receive a W-2. If you work on a commission-only basis, however, you're probably an independent sales representative. You should receive a 1099 at tax time, but even if you don't, and particularly if your income isn't reported on a W-2 either, you're still responsible for reporting it to the IRS.
Penalties for Misclassification
It can be tempting for an employer to classify a worker as an independent contractor, because it will save the company money. If you're an employee, your employer must pay half your Social Security and Medicare taxes for the year. If you're an independent contractor, you must pay all these taxes yourself as self-employment tax. If your employer classifies you as an independent contractor when you're actually an employee, he can be held liable for paying all Social Security and Medicare taxes for the year, not just half, and he can be subject to fines as well.
Reporting the Income at Tax Time
Tax filing is comparatively easy for employees: Your taxable wages appear on your W-2 and you enter them on line 7 of Form 1040. Then you must decide if you want to take the standard deduction or itemize. If you want to claim work-related tax deductions, you must itemize. This means completing Form 2106 and listing your work-related expenses. You can then deduct the amount that exceeds 2 percent of your adjusted gross income. You would include this number on Schedule A along with all your other itemized deductions.
If you receive income as an independent contractor, you must report on Schedule C the income that appears on your 1099-Misc. The good news is that you can subtract 100 percent of your business expenses on Schedule C as well, and there's no 2-percent threshold. After you complete Schedule C, the resulting number is the income you would report on line 12 of your tax return as business income.
When You Have More Than One Kind of Income
If you receive income as both an independent contractor and an employee, you would include both on your tax return. Your W-2 wages would go on line 7 and after taking your business deductions on Schedule C, your 1099 income would go on line 12. The same applies if you're married and want to file a joint return with your spouse. One of you may be an independent contractor while the other is an employee, but you can report your respective incomes on Form 1040 in the same way.
- Internal Revenue Service: Independent Contractor (Self-Employed) or Employee?
- H&R Block: Can I Receive a Form W-2 and a Form 1099 From the Same Employer?
- Freelance Taxation: What Should Freelancers Do With Both W-2 and 1099 Income and Expenses?
- FindLaw: Your Sole Proprietorship and Your Spouse
- IRS Tax Attorney: What Are Independent 1099 Sales Reps?
- TurboTax: Penalties for Not Filing a 1099-Misc IRS Form
- Internal Revenue Service: Form 1040 (PDF)
- TurboTax: Bonus Time -- How Bonuses Are Taxed and Treated by the IRS