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The sluggish economy has done wonders for keeping freelancers employed, but chances are they still can't tell the difference between a W2 and 1099, which matters more than they think.
With this year's tax extension deadline coming up on October 15, we thought now was as good a time as any to clarify which form is which, and whether workers can tip a return in their favor (hint: they can a little).
First, a W2 is the form employees use, while 1099 Miscellaneous forms are for freelancers.
"The IRS doesn't have any specific set of factors that makes a worker an employee or an independent contractor," says tax expert and Bankrate blogger Kay Bell. "And no one factor stands alone in making this determination. It's the classic facts and circumstances test."
But the key is to look at how much control a payer has over the freelancer's work, from set hours to benefits (i.e. pension plan, insurance, vacation pay, etc.), and who's providing the tools and supplies.
"If the worker is in charge of how the work is done, i.e. given an assignment and then left alone to complete it the best way he/she sees fit using his/her tools, etc. that person is an independent contractor," she says.
The trouble with 1099s
There are three glaring issues with 1099s: They're unpredictable, create more paperwork and are generally more costly to taxpayers, says Erb. Due to the unpredictable nature of freelance work, 1099s tend to differ from month to month.
"If I freelance and try to get magazine articles, the chances of my pay being the same are really slim," says tax attorney and Forbes blogger Kelly Phillips Erb. "Maybe Time will call, but then I won't hear from them next year or vice versa."
There are also state and local taxes to be paid, which require more forms, along with 1099s, that have
to be filled out four times a year. This leaves more room for error, she says, as people underestimate how much they need to pay. "People who get snowed over, nine times out of ten, it's a withholding issue."
Self-employed freelancers must also pay the entire FICA portion (Social Security and Medicare) of their taxes. "You do get a credit for paying part of it, but you still have to pay it out-of-pocket," Erb says.
The beauty of W2s
With a W2, most taxes are cut and dry. The employer pays half the FICA portion, and the potential for making a mistake is much smaller. "The W2 is spelled out," says Erb, "and most of the pay is regular." What's more, there is only one form to look out for at the end of the year.
Says Bell: "Being an employee has the advantage of benefits (generally tax-free to the worker) and the payroll taxes being paid by the employer. All they have to worry about at tax time is getting a W2 and transferring that info to the 1040."
So is there any recourse?
There is a little. Though filing a W2 and 1099 is "never the employee's choice," says Erb, self-employed workers should speak up if they're being classified incorrectly by their employer.
"He or she can discuss it with the employer and even report the employer to the IRS," says Bell. "Some employers try to exert control (providing the workplace, equipment, closely monitoring the work, etc.) and still want to carry the person as a contractor because then they don't have to deal with benefits costs or labor rules (overtime, etc.) or the employer portion of payroll (Social Security/Medicare) taxes."
Above everything, make sure to keep track of your papers and consider hiring a legit tax preparer to do the dirty work.
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