Nonemployment compensation, or nonemployee compensation as it’s more commonly known, generally refers to the money you earn through self-employment activities. Nonemployee compensation is usually discussed in an income tax context, since the people or companies who pay you the compensation usually report the payments on a 1099-MISC form in the “Nonemployee Compensation” box.
Independent Contractor vs. Employee
The differences may be subtle, but the laws treat employees differently than independent contractors and other self-employed individuals. There isn’t a standard test to determine which category you fall under, but the law takes into account several factors. These factors reasonably lead to the conclusion that you’re self-employed, and therefore you receive nonemployee compensation, including having independence and control over how and when you work. Moreover, establishing the terms of how and when you get paid, lack of a written contract and benefits normally provided to employees also indicate that the money you earn is nonemployee compensation, according to the Internal Revenue Service, or IRS.
Employees receive a W-2 form from their employers each year that reports the amount of income, taxes withheld and other relevant financial information reported on a tax return. As a self-employed individual, however, you’ll likely receive a number of 1099-MISC forms since each of your clients that make annual payments to you for services rendered that total $600 or more have a legal obligation to report all payments in box 7 of Form 1099-MISC as nonemployee compensation, note the IRS.
Reporting Nonemployee Compensation
Shortly after the close of the tax year, you will receive your 1099-MISC forms. The first thing you may notice is that whoever prepares your tax form reports a single number for nonemployee compensation without any reduction for tax withholding, which is only done for employees. Since income taxes aren’t withheld, you may find it necessary to make estimated income tax payments during the year to the IRS. When you fill out your tax form, you simply add together the amounts reported in box 7 on all of your 1099-MISC forms and report the total on a Schedule C or C-EZ. A significant benefit to receiving nonemployee compensation is that you can deduct many of the business expenses you incur, which ultimately reduces the amount of income you’ll report on a 1040 form and reduces your income tax bill.
Paying Self-Employment Tax
A drawback to receiving nonemployee compensation is that you’re responsible for paying 100 percent of the same Social Security and Medicare taxes that employees do, though employees only pay 50 percent, while employers pay the other half. As a result, you need to file a Schedule SE with your taxes to figure out how much self-employment tax you owe. Since you don’t have an employer paying part of these taxes for you, the IRS allows you to take a deduction for half of these taxes on the 1040 form.
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