Whenever tax season comes along, it seems like everyone’s finances get a little hectic. Many of the employed expect some sort of tax rebate due to write offs and other credits. On the flip side, a lot of self employed workers have to pay their taxes in full at this time if they haven’t been paying quarterly (which I’d recommend).
Handling your taxes can be tricky, and more so for the self employed and contract workers. Since employees who are taxed regularly from their payroll checks handle their taxes differently than those who do not see regular deductions from their paychecks, each group has a different tax form: The 1099 and the W-2.
What is a W-2 Form?
A W-2 form is also called a Wage and Tax Statement, since that is the information addressed on the form. At the end of each fiscal year, employers are required to send a W-2 form to each of their employees, as well as the Internal Revenue Service (IRS). Employees note their total earnings on the form as well as the amount of taxes they paid that year directly from their paychecks.
W-2 forms are meant for employees who pay taxes with each paycheck. Employees are required to report their earnings and paid taxes to the IRS by sending the W-2 to the government.
Employers must send the W-2 form to each employee by January 31st so that employees can file their taxes by the deadline, which is usually April 15. Information applies to the entire previous year, so employees filling out a W-2 in January of 2021 will be referring to their income for all of 2020.
The IRS uses the information from W-2 forms to ensure that employees are reporting the same amount of income when filing their taxes. A difference in reported income could result in an audit by the IRS, where the agency asks for more concrete proof of income and for the taxpayer to explain the discrepancy. Being caught in a lie on your tax information could result in penalties and even jail time.
What is on a W-2 Form?
All W-2 forms are standardized no matter the employer, industry or state. Since taxes are divided between state and federal jurisdictions, the W-2 includes separate sections for each. Employees must identify themselves and their employers using their social security number, employer identification number and both parties’ addresses.
Beyond identifying information, all other fields relate directly to wages earned and taxes paid. These include total earnings, additional tips, medicare wages, federal and state taxes, medicare taxes and social security taxes.
The IRS compares the taxpayer’s total tax obligation, which is how much they are expected to pay in taxes based on their income, to their total amount of taxes withheld. If an employee has paid more in taxes from their paycheck withholdings than their total tax obligation, they may be entitled to a tax refund. For instance, if a taxpayer has paid $10,000 in taxes with an obligation of only $8,000, they will receive a $2,000 tax return.
Of course, the opposite can occur as well. If so, you will then be writing a check to the IRS.
Understanding the W-2
In order to properly fill out the W-2 form, refer to all information relating to your pay stubs. Information like total earnings and total deductions are noted with each paycheck, so the final pay stub from the year will usually contain all of the information needed to fill out the W-2 form correctly.
If you have any questions regarding your W-2 form consult your employer, a financial advisor or a knowledgeable acquaintance. Here is some additional information on how to properly fill out the W-2 form. Remember to always fill out all tax related information honestly and completely to avoid an audit.
Even if you are completely innocent, responding to an audit is time consuming and can be a very stressful endeavor. Consult a Certified Public Accountant (CPA) with all of your questions to avoid any mishaps.
What is a 1099?
Like the W-2, the 1099 form is used by the IRS to collect information relating to earnings. However, 1099 forms are primarily focused on income that is not tied to a reported or taxed salary. There are a variety of types of 1099 forms which each focus on a specific niche transaction type.
Overall, 1099 forms record basically every type of significant transaction or earning that is not done through regular employment. Contract workers, day traders and the self employed are just a few examples of the kinds of people who would fill out a 1099 form.
Like the W-2, 1099 forms are laid out in a similar manner to note both parties involved in the transaction, total earnings and withheld taxes, as well as such information prevalent to the specific 1099 form. Usually, the party paying or expending money for the transaction sends the recipient party a 1099 form.
While the W-2 comes in one size fits all, there are about two dozen different 1099 forms. If you are issued any 1099, it is important to double check that you are receiving the correct one that relates specifically to the transaction you were involved in.
Types of 1099 Forms
Unlike the W-2, which exists as only one kind, there are many variations of the 1099 which serve specific purposes. Activities such as contract work, real estate transactions and stock or bond transactions use 1099 forms in order to record information with the IRS. All information collected from 1099 forms is used to corroborate the information submitted when a taxpayer files their taxes.
Each 1099 form has a specific purpose and handles information relating to a specific category. There is the 1099-S, which is used to report earnings from a piece of sold real estate by the person selling it. The 1099-A records information regarding real estate sold due to a foreclosure. These forms are similar in topic so it can be easy to mix them up.
One of the most commonly used 1099 forms is 1099-Misc. This form specifically handles income earned by independent contractors, freelance workers, sole proprietors and other self-employed individuals. In the United States there is a significant rise in freelance workers, who now compose of 36% of the American workforce.
That means that the 1099 will become one of the key forms used by the average American when it comes to filing taxes. Anyone in the above listed occupational regards must receive a 1099-Misc form from all clients who paid them at least $600 during the course of the year. 1099-Misc forms handle other income factors, including earnings from rent payments, medical payments, royalties, commercial fishing and attorney work.
The 1099-Div is another common 1099 form, and is used for reported dividends from stocks and/or mutual funds, or any other type of investment. Financial institutions are responsible for sending the form to investors. Most retirement related investments are exempt from filing on the 1099-Div.
And a final popular 1099 is the 1099-INT which handles all interest earned from a bank account, indebtedness and life insurance accumulated dividends. The form must only be used if the total interest dispersed is over $10. The financial institution issuing the interest sends each recipient the 1099-INT form.
The Importance of Proper Filing
Making sure that you take the time to look over your financial records so that you can file the correct information could save you from dealing with a complication. Messing up even accidentally when filing your tax information could cause the IRS to give you a massive headache. The best way to make sure that you are filing the correct tax form is to work with an experienced financial advisor or CPA.
Here at NextGen Wealth, we offer tax planning so that you can better predict a financial course while taking your taxes into account. We take the time to look through your financial situation so that you are best prepared for a financially healthy future into retirement.If you need help with tax planning, or are curious about how you can better prepare yourself for the best retirement possible, take advantage of our Free Retirement Checkup today! Just a 15 minute phone call can put you on the right track towards creating a future you can truly enjoy.