An employee working directly for a company receives fringe benefits, has payroll withholding for taxes from each paycheck and is covered by workers' compensation insurance provided by the employer. The employee is told how and where to work, with direct supervision from a supervisor. From a tax point of view, the employee receives a Form W-2, showing total income, federal and state taxes withheld, Social Security tax and Medicare tax.
If you are an employee receiving a W-2, the information would be posted on the "wages, salaries, tips, etc." line of the Forms 1040EZ, 1040A, or 1040. The forms require the attachment of W-2's, showing the withholdings. This income is treated just like hourly wages or salary income, except that it was earned through a commission formula.
Independent Contractor Commissions
An independent contractor usually works for more than one company, works without supervision and receives compensation without any withholding. This taxpayer is regarded as self-employed, receives a Form 1099-MISC reporting year-end income, and reports income and expenses on a Form 1040, Schedule C.
The Schedule C is like a profit-and-loss statement. Total revenue from all of the 1099-MISC forms is reported, along with expenses, to calculate the actual net income for the year. The self-employed person has the tax benefit of being able to subtract any and all business-related expenses to reduce the net income reported.
Taxes On Commissions
If you are an employee reporting commission income, the tax is calculated by including the commissions in your total taxable income and factoring it by the appropriate tax rate. It is just like receiving income as hourly wages or salaries.
The independent contractor's taxes are more complicated. The first tax computed is the Self-Employment tax shown on Schedule SE. This tax is levied on the net income, after reporting all expenses. Since the independent contractor did not have Social Security and Medicare taxes withheld from compensation, the Self-Employment tax collects the equivalent with a rate of 15.3 percent but 13.3 for 2011. For employees, the Social Security and Medicare taxes are split between the employer and employee. For the self-employed, the full tax must be paid by the taxpayer.
The net income from Schedule C is added to all other income to determine total taxable income, which is factored by the appropriate tax rate.
Independent Contractor Advantages And Disadvantages
The independent contractor has the advantages of being able to work for multiple employers, having flexibility as to time and deadlines and charging a billing rate appropriate for an independent professional.
The disadvantages of being an independent contractor include having to pay the Self-Employment tax, not having a steady weekly income, no fringe benefits and lack of workers' compensation insurance in case of injury on the job.