The Drawbacks of Self-Employment Income
What is self-employment income?
Put simply, 1099 or self-employment (SE) income is income generated from contract services. Contract services are business activities you perform for someone or an entity for which you are not employed. After year-end, instead of receiving a W-2 you will receive a Form 1099. Performing work as an independent contractor has its advantages and can be quite appealing. Independent contractors can set their own hours. They don’t have a boss breathing down their neck constantly. Many times, companies will pay you a higher hourly or daily rate as an independent contractor, but there are drawbacks.
Am I an employee or an independent contractor?
There are a few basic questions you should consider to determine if you’re an employee or an independent contractor:
· Do you have a signed agreement for employment? If yes, you are an employee.
· Does the individual or company for which you’re performing the work have control over every aspect of the project and how you are to perform you daily tasks? If yes, it’s likely you’re an employee.
· Will the working relationship continue indefinitely? If this is a permanent working relationship, it’s likely you are an employee.
If the answer is “no” to each of the questions above, then you are likely working as an independent contractor.
Why have I been approached to work as an independent contractor as opposed to as an employee?
Hiring independent contractors to fill the gaps, within a company, as opposed to hiring more employees is attractive to many employers. Independent contractors can offer quite the cost savings as opposed to hiring more employees. ‘Even if they offer to pay me at an hourly rate above what I was expecting as an employee?’ Yes, hiring an additional employee means acquiring the cost of an additional benefits package and the employer portion of payroll taxes. I’ve seen employers use this strategy for cost savings, and many times the independent contractor does not understand the tax implications until it’s too late.
How does 1099 income affect my tax return?
Over the years, I’ve had several clients with self-employed income get hit with a big tax bill after year end, and many times it comes as a shock. This shock is especially prevalent in individuals who are new to world of being self-employed. While working as an employee, the employer pays FICA taxes (Social Security tax and Medicare tax) at a combined rate of 7.65% while the employee pays FICA taxes on their wages at the same rate as the employer – together you and the employer are paying 15.3% in FICA taxes on the wages you earn as an employee. The employer withholds the portion you owe on FICA taxes and submits the payment for you throughout the year. When you work as an independent contractor, you must pay the employer portion and the employee portion of the FICA taxes due on your income. So instead of only 7.65% being withheld from your wages to pay your portion of the FICA taxes due, you will owe the entire 15.3%. And to complicate things further no one is withholding and paying your FICA taxes due on your income. Being self-employed, it’s now your responsibility to do some tax planning and make quarterly estimated payments.
To illustrate, a single taxpayer who earns $100,000 in self-employed income during 2019 will be taxed at a marginal tax rate of 24% and will owe an additional 15.3% in FICA taxes. That’s $15,300 owed just for FICA taxes. If you have poor tax planning during the year the amount due on your tax return can come as quite the surprise. Don’t get caught in this situation with a tax bill you can’t afford. Reach out to me at jconner@conner-cpa.com or at (863) 268-4374 so we can setup a free consultation to discuss tax saving strategies before year end.