Payroll Taxes – Wilson Rogers & Company

Tax Impact of being 1099 vs. a W2 Employee

So back in this post we reviewed how an employer goes about classifying a worker as either an employee or an independent contractor. However, what if you are on the receiving end of that classification? What is the financial and tax impact of receiving your pay either via W2 or 1099? In this post will follow the exploits of two workers, Suzy Salary and Contractor Chuck. To keep this example simple and straightforward, we’ll assume the following about both Suzy and Chuck:

Work similar jobs (with different companies)
Don’t have any pretax contributions coming out of their checks
Each make $100,000 per year
Are both single without any dependents and take the standard deduction
Didn’t have any Federal income taxes withheld from their checks (i.e. Suzy didn’t have these deducted from her check, but we’ll assume Social Security and Medicare were withheld)
IRS penalties don’t apply
We’ll ignore the whole 2% payroll holiday that has been in effect the past few years

Amount Earned The easiest difference to spot will be in the amount of their checks. Suzy will take home about $93,800 (due to combined 7.65% withholding of Social Security and Medicare) while Chuck will take home the full $100,000. However, it gets interesting when the two actually go to file their tax returns.

Self Employment Taxes The basic concept to remember with this is that when you work for someone, you and they split the Social Security and Medicare taxes equally (i.e. 7.65% for each of you). However, when you are self employed, you have to foot the whole bill or 13.3% up to income of $106,800. True you will see an adjustment on the 1^st page of your tax return (it’s labeled “Deductible part of self-employment tax”), however due to the nature of the calculations, it doesn’t yield you a true 50% benefit.

Bottom Line Tax Impact At the end of it all, Suzy will wind up paying about $18,957 in income taxes and $6,200 in Social Security and Medicare for a total of $25,157. Chuck on the other hand will pay $16,979 in income taxes and $12,283 in self employment for a total of $29,262. Total tax bill difference winds up costing about $4,105.

Why Bother Being 1099? If your employer gives you the option between the two, the W2 option will more than likely put you at ease. You won’t have to worry about setting cash aside for your taxes bills as your boss will simply withhold them. However, the truth of the matter is that most individuals who are “truly” considered contractors actually may pay a lower tax bill due to having expenses associated with earning their income. For example, a cable installer will typically have the cost of keeping up their vehicle, supplies necessary to perform the work as well possible office related expenses. In the end, they can deduct these allowable expenses on their return whereas an employee cannot.

So if faced with a choice of which type of way you would like to be paid, take the time to consult with your tax practitioner as they can advise you on the possible ramifications of your particular situation.

Hiring Your First Employee & Payroll Taxes

So, in this post we discussed the trials and tribulations of finding the perfect employee for your company. Now we’ll take a look at the tax implications so you keep yourself out of hot water with the regulators, or said another way, what ever employer should know BEFORE they hire their first employee.

Eligibility to Work in the United States. Every employer must verify that each new employee is legally eligible to work in the United States. You don’t want to run into problems later so have the employees you hire fill out Form I-9, Employment Eligibility Verification. You can also get their SSN at this stage.

Employee vs. Independent contractor. While you may want to classify a person as independent contractor to avoid the hassle of dealing with payroll taxes, make sure the classification is proper. Generally speaking, an individual is an independent contractor if the payer 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. Not sure what your new hire will be? Check out this site for a little assistance.

Independent Contractors Agreement. If you do determine that the person who’ll work for you does qualify to be classified as an independent contractor, it’s a good idea to draft an agreement. This document should outline the duties they will/won’t perform, how they are compensated and the responsibilities with reporting their earnings to the IRS. This way you are protected in case the employee disagrees that they were an independent contractor or worse files a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

Fill out Form W4. To know how much income tax to withhold from an employees’ wages, you should have them complete Form W-4, Employee’s Withholding Allowance Certificate. Ask all new employees to give you a signed Form W-4 when they start work. Make the form effective with the first wage payment. If the employee claims exemption from income tax withholding, they must indicate this on their W-4. The amount of income tax withholding must be based on filing status and withholding allowances as indicated on the form. If a new employee does not give you a completed Form W-4, the IRS recommends that you withhold tax as if he or she is single, with no withholding allowances.

Withholding & Matching Taxes. So as an employer you will act as a collector and depositor of taxes. You should withhold the proper amount of federal income tax based on the employees Form W4. Additionally, you are required to withhold social security and Medicare taxes from your employees’ wages and pay the employer’s share of these taxes. Generally speaking the employee AND employer tax rate for social security is 6.2% on wages while the tax rate for Medicare is 1.45% each for the employee and employer (2.9% total). All of the above is deposited via a system called EFTPS by the employer.

Reporting. In addition to withholding and depositing payroll taxes, employers must periodically report these amounts to the government. These are done via Form 940, 941 or 944. You may be asking yourself “What is the difference between Federal 940, 941 and 944 taxes?” 941 tax filings are submitted each quarter. 944 tax is the same as the 941, but is filed and paid on an annual basis. The IRS makes the determination on which tax form you will file and how often you need to deposit your tax withholdings depending on the size of your payroll. 940 tax is Federal Unemployment. Unless you are exempt, you are required to report/pay this tax on an annual basis in addition to your 941 or 944 taxes.

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