Transitioning From W-2 Employee to 1099 SEI

There are various reasons individuals choose to transition from employee to self-employed individual (SEI). When making the transition, one area of importance to clearly understand and keep top of mind is the handling of taxes.

Both employees and self-employed individuals are subject to tax liabilities and must pay their share of taxes.

For W-2 employees, taxes (payroll taxes) are typically withheld subject to an employee’s Form W-4 and applicable laws. Payroll taxes are subsequently remitted to the appropriate tax agencies by employers or their respective payroll companies.

When you file your tax returns, if your tax withholding was insufficient to cover your tax liability over the course of the year, you may owe taxes. Similarly, if your tax withholding exceeded your tax liability, you may be due a refund.

For 1099 SEIs, taxes are not withheld from payments made to self-employed individuals. Self-employed individuals are responsible for remitting their share of self-employment and income taxes on a quarterly basis in the form of estimated tax payments. To avoid potential penalties for underpayments, SEIs should typically make estimated tax payments in line with safe harbor rules.

Basic mistakes SEIs may make include failing to set aside monies to cover tax liabilities, failure to make estimated quarterly tax payments, significantly underpaying estimated taxes, and/or waiting until tax time to make any tax payments (which can result in significant penalties).

If you’re considering making the transition to SEI, become well-informed on how income and taxes apply as an SEI vs W-2 employee. Your business entity structure can also impact how you get paid and how taxes are handled (ex: members of an LLC taxed as a Partnership vs shareholder/employees of an LLC taxed as an S-Corp).

Consult with a reputable CPA to discuss tax implications and obtain relevant tax guidance for your tax situation and business.

Be proactive, not reactive!