A subcontractor is not an employee of a company. Instead, the subcontractor is an independent business person. Because of this, taxes are handled much differently than if the subcontractor were an employee of the company. You should understand how much of the amount shown on your Form 1099 you will pay in taxes when you file, because this helps you plan during the year for an inevitable tax bill.
Significance
As a 1099 contracted worker, no taxes are withheld from your paycheck. The company you do business with may imply an employee-employer relationship with you. However, the reality is that you are an independent businessperson. This means you pay your own income taxes. This money should be sent to the IRS in quarterly installments throughout the year to avoid an IRS penalty when you file your tax return.
Tax Deductions
You may take business tax deductions as an independent businessperson. All expenses you incur as the result of doing business are deductions you take off of your income. This is recorded on Schedule C, under “gain or loss from a business,” on your tax return. These deductions are important, because they provides a way for you to itemize deductions and dramatically reduce your adjusted gross income. This, in turn, allows you to reduce your income tax liability.
Effect
The amount of tax you pay on the income shown on your Form 1099 depends on your tax bracket. The federal tax system is progressive, using tax brackets, starting at 10 percent and increasing to 35 percent (as of 2011). This progressive tax means that, as your income increases beyond the income threshold for each bracket, all income beyond that threshold is taxed in the higher bracket. State income taxes vary by state. The tax you pay also depends on your available tax deductions and the adjusted gross income after such deductions are taken. The deductions depend on the nature of your business. Being a 1099 employee is more complex than being an employee of a company, because you must track all expenses and income yourself and make sure you set aside money to pay your taxes throughout the year.
Consideration
As a 1099 employee, you must also pay self-employment tax, called SECA. A tax rate of 15.3 percent is assessed on your income. You must pay this amount of money each year. Your payment provides you with Social Security benefits when you retire from work. This tax is similar to FICA taxes that employees pay, except you pay what an employer would otherwise pay plus the amount the employee normally pays.