You got your first paycheck, did the math, and something's wrong. You worked 80 hours at $25/hour — that's $2,000 — but the deposit says $1,624. Nobody stole from you. You just met the tax system. This lesson explains where that money went, and why how you're paid (W-2 employee vs 1099 contractor) changes everything.
The big picture: pay-as-you-go
The United States taxes income as you earn it, not in one giant bill in April. Every paycheck, your employer sends a slice of your money to the government on your behalf. This is called withholding.
Then, once a year (the famous April 15 deadline), you file a tax return — a form that calculates what you actually owed for the year. You compare that to what was withheld:
- Withheld more than you owed? You get a refund.
- Withheld less than you owed? You write a check for the difference.
A tax return isn't a bill — it's a reconciliation. Keep that in mind; it makes everything else click.
What actually comes out of your paycheck
Let's break down that $2,000 paycheck. A single person in 2025 earning $25/hour full-time (about $52,000/year) would typically see deductions like these:
| Deduction | Roughly | What it funds |
|---|---|---|
| Federal income tax | ~$180 | Roads, defense, schools, federal programs |
| Social Security (6.2%) | $124 | Retirement & disability benefits |
| Medicare (1.45%) | $29 | Health coverage for people 65+ |
| State income tax (varies) | ~$43 | Your state's budget (some states have none) |
| Take-home | ~$1,624 | You |
Two things to notice:
- Social Security + Medicare (together called FICA, 7.65% total) come out of every paycheck at a flat rate. There's no avoiding them as an employee — and your employer quietly pays a matching 7.65% on top. Remember this; it matters for the 1099 section.
- Federal income tax is not a flat rate. It's an estimate based on your pay and the W-4 form you filled out when you were hired. We'll cover exactly how the rate is calculated in the next lesson on brackets.
W-2 vs 1099: two very different deals
Those form numbers are just the names of the tax documents you get in January, but they represent two completely different working arrangements.
W-2: you're an employee
If you're an employee, your employer:
- Withholds taxes from every paycheck for you,
- Pays half of your FICA (they pay 7.65%, you pay 7.65%),
- May offer benefits: health insurance, a 401(k), paid time off,
- Sends you a Form W-2 each January summarizing your pay and withholding.
Filing taxes as a W-2 employee is usually simple: copy a few boxes into your tax return (or tax software does it for you), and you're mostly done.
1099: you're your own business
If you freelance, drive for a rideshare app, or contract — you'll get a Form 1099-NEC from each client that paid you $600+. Now you are the employer, which means:
- Nothing is withheld. That $1,000 client payment is 100% pre-tax money. A chunk of it is not yours.
- You pay both halves of FICA — the full 15.3% — called self-employment tax.
- You must send the IRS quarterly estimated payments (April, June, September, January) instead of waiting until tax season.
- No benefits, no employer 401(k), no paid leave.
In exchange, you get flexibility and the ability to deduct business expenses (equipment, mileage, a home office) before tax is calculated.
Why this matters at job-offer time
A $30/hour 1099 contract is not better than a $26/hour W-2 job with benefits. Once you subtract the extra 7.65% self-employment tax, health insurance you'd have to buy yourself, unpaid time off, and the missing 401(k) match, that contract often nets less. A common rule of thumb: a 1099 rate needs to be ~20–30% higher than a W-2 wage just to break even.