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freelancers/independent contractors

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Taxpayer asks:

Since the self-employment tax rate is 12.4 percent, why do I have to pay 15.3%?

taxgirl says:

Self-employment tax, sometimes called SE tax, is a tax consisting of Social Security and Medicare taxes for those who work for themselves. It’s the equivalent of the total of Social Security and Medicare taxes, sometimes called FICA taxes, withheld from an employee plus the amount paid out by an employer. In other words, the self-employed pay both parts (yes, there’s a credit but that’s a separate post). You figure SE tax by using Schedule SE on your form 1040.

The 12.4% figure you reference is the Social Security portion of the tax. You get to the 15.3% by adding in your contribution for Medicare taxes, which works out to 1.45% each for employer and employee, or 2.9% for self-employed. The total is 15.3% (12.4% + 2.9%).

The 15.3% does not apply to all self-employed wages. For 2011, the first $106,800 of your combined wages, tips, and net earnings are subject to the Social Security part of self-employment tax; the overage is not. There is no cap on Medicare taxes. Here’s a quick comparison:

Example 1: Your self-employment income is $100,000. All of the income would be subject to the full amount of taxes for Social Security taxes and Medicare which, in 2010, would have been $15,300 (15.3% of $100,000).

Example 2: Your self-employment income is $110,000. Your income to $106,800 is subject to Social Security tax of 12.4% on the first $106,800 plus Medicare taxes on the entire $110,000 which, in 2010, would have been $16,433.20 (12.4% of $106,800 + 2.9% of $110,000).

That said, for one year only, in 2011, there is a payroll tax holiday, which reduces payroll tax contributions. The break applies to the self-employed by the same 2%, so that instead of paying in at 6.2% for the “employee equivalent” part of the Social Security taxes, contributions are 4.2% for Social Security taxes. Contributions for Medicare remained the same. That makes the total 13.3% (4.2% + 6.2% + 1.45% + 1.45%) for 2011.

Assuming that nothing changes, the rate will go back to the full amount in 2012.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

A place paid for me $663 for services performed. They said they will send me a 1099 at the end of the year. How do I figure the taxes to take out?

Taxgirl says:

If you are paid without having any taxes withheld (meaning, generally, that you’re going to receive a form 1099) and you think that you are going to owe taxes come tax time, you should consider making estimated payments throughout the year to avoid any penalties. This applies not only to the self-employed or occasional freelancers but also to those taxpayers who may receive income from other sources not subject to withholding; these tend to be landlords, S corporation shareholders, partners in a partnership or taxpayers with significant investments.

If you are filing as an individual taxpayer, you generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your federal income tax return. If you owed federal income tax last year and expect to owe again this year, you may also have to pay estimated tax for the current year. Some exceptions and special rules apply, so check out federal form 1040-ES (downloads as a PDF) for more information.

There are some differences in payments due, depending on the nature of your payments: if you are self-employed, for example, you’ll need to figure any self-employment tax due, as well as your income tax due.

To make estimated payments, you’ll figure your estimated tax; you can use the worksheet on the federal form 1040-ES to figure your estimated tax. For estimated tax purposes, the year is divided into four payment periods, about once every quarter. Each period has a specific payment due date as determined by IRS (usually April 15, June 15, September 15 and January 15). Watch the dates carefully: if you don’t pay on time, you may be subject to a penalty.

You can also use a commercial software package (like TurboTax or CompleteTax) to figure your estimated tax. There is usually an option at the end of the package to figure any estimated tax due for the coming year and print any payment vouchers. A good tax professional will also figure this for you (for the next year) when they prepare your returns; if you expect your income to be different in the coming year, let your preparer know.

I’m assuming, due to the amount of the payment in your question, that you usually have other income subject to withholding. If you want to avoid making estimated payments altogether, you can also adjust your withholding with your employer using a federal form W-4 (downloads as a PDF). To help you figure out how much additional (if any) to withhold, try the IRS’ withholding estimator.

Don’t forget that, depending on where you live, the income might also be subject to state and local taxes. You might need to make estimated taxes for those, too.

Like any good lawyer, I need to add a disclaimer: unfortunately, it is impossible to offer comprehensive tax info over the internet, no matter how well researched or written. And remember, I love my readers but having me bookmarked on your computer doesn’t make you a client: before relying on any information given on this site, contact a tax professional to discuss your particular situation.

Taxpayer asks:

Hi Tax Girl,

Thanks for taking questions. It’s a really nice thing to do.

I have a trio that performs regularly and this year the venue sent me a W-9. I know it is just for informational purposes in preperaion for a 1099, but should they be sendind one to just me or should the other band members also receive the fom?

They pay us by check, the check is made out to myself in the full amount and I then pay the additional musicians. It looks like they may 1099 me or are setting up to 1099 me for the full amount at tax time. How do I ensure I only pay tax on my 1/3 and how do I or the venue hold the other 2 musicians accountable?

Thanks.

Taxgirl says:

Ideally, the forms W-9 and the forms 1099 would be issued to the trio, and not to you individually.

I am going to assume that the trio is not incorporated and does not have its own taxpayer ID number. I’m also going to assume that you are the member of the trio who typically signs the contracts and manages the money.

So, here’s the scoop. If the form 1099 is issued to you, the IRS is going to be looking for that income on your return. So I’d advise against merely splitting the 1099 among the members of the trio and calling it a day, which is what tends to happen. Under the circumstances as you’ve explained them, I’d include the whole amount on your return and then deduct the amounts paid out to the members of the trio, as if they were subcontractors. If you have good records, you’ll be fine with respect to reporting.

But here’s my big caveat: depending on the amount and how it’s classified (as a hobby or business), reporting the full amount will artificially inflate your gross income, even though your net income may be roughly the same. You could have unintended tax consequences, especially if you live in a state or locality that taxes gross income or if the amounts are significant.

I’ve represented a lot of groups, including musicians, theatre groups, and artist collaborations. And even though I know this “one check to a member” system is something that happens all of the time, it just isn’t ideal. The record-keeping is all on the member with the check (especially since it’s your tax ID number being reported to the IRS) and things can get complicated. Technically, you should be issuing forms 1099 to your band members for their respective share of the pie and you should be keeping the records of what expenses were paid out of the check, etc. Of course, everyone else is just walking away with a check, while you stare at a spreadsheet and try to work out what’s what. It can cause hard feelings, create disputes, and often results in a mess.

So, I have two suggestions for the future, depending on your plans. If this is something that’s always going to be a hobby, be very clear with the payor that you want separate checks for the members of the trio. And fill out three forms W-9. Despite the fact that the payor may initially hem and haw, in today’s Quickbooks/Quicken/Peachtree kind of world, it’s really no more work to issue one check as three. And if it’s a club or other organization issuing the check, they have an accountant who does all of that kind of stuff anyway, so it’s not a real burden: don’t let them convince you otherwise. Now, the record-keeping and reporting requirements become the responsibility of each individual member of the group and not just on you.

Going forward, if your trio is something that’s going to be a real business venture, meaning you hope to do it to earn a living, I’d consider incorporating or at the very least, loosely organizing as a partnership and securing a taxpayer ID number for the group. Then you pay expenses out of the group first, then split the checks. I’d highly recommend that you talk to a tax or entertainment lawyer about whether this makes sense for your group.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

I was working as an independent contractor in this small company. At that time, I was getting paid with no taxes being withheld. I assumed I was getting paid under the table, but 6 months after I stopped working there I received a phone call from them asking for my SSN. I did not give them my SSN.

Also, during the time I was working for them I was collecting unemployment insurance and since no taxes were being withheld I was declaring I was not working so I could keep collecting EDD money.

Do I have any rights to withhold my SSN after 6 months not working for them. I’m afraid if I do give them my SSN and didnt declare this income I will get penalized for not declaring income to EDD.

Any advice for me?

Taxgirl says:

It’s important to remember that your employer is not your friend. An employer who suggests that you might be paid “under the table” is definitely not your friend, for about a million reasons.

No matter how many times an employer thinks it might be cheaper to pay you under the table, it’s not. An employer’s share of taxes attributable to an employer is ultimately much smaller than the share of taxes attributable to an employee. Additionally, wages paid to employees and independent contractor are also deductible as a business expense. So, from a financial perspective, it makes more sense for an employer to report wages paid – even if they implied to you that they wouldn’t – not to mention that it’s, you know, illegal. There are all kinds of nasty things that can happen to an employer if they don’t report you properly and then you get laid off, injured, or become spiteful.

That said, just because you weren’t having taxes withheld does not mean that they were paying you under the table. If you were, in fact, properly classified as an independent contractor (and not an employee), the employer would not have been required to withhold taxes. It may have been their intention all along to claim you and they just weren’t terribly organized… Nonetheless, the employer should have clearly indicated to you the terms of your employment, including how you would be classified and paid. You should have also been asked to complete a federal form W-4 (for an employee) or a federal form W-9 (for an independent contractor).

It sounds like that didn’t happen. But now, it sounds as if they’re trying to do things on the up and up, and they want to issue you a form 1099 reporting your compensation. Your refusal to turn over your Social Security number won’t prevent them from reporting your compensation to the IRS. Most likely, they will write “REFUSED” in the space where your Social Security number should go and send it to the IRS.

You will be subject to a fine for not providing your Social Security number for purposes of the form 1099. The biggest issue here isn’t so much the fine but the fact that you’re going to open your tax return up for scrutiny. The IRS will receive a form 1099 with your name on it. If you don’t report the compensation associated with that form 1099, your tax return will likely be flagged for review. If you haven’t reported your compensation, you will be responsible for the taxes associated with the income as well as penalties and interest.

As for your unemployment compensation issue, that gets tricky. Unemployment compensation is paid out of funds which are pooled from federal unemployment and state unemployment taxes and insurance. Cheating, by claiming unemployment compensation when you are working, actually drives up the costs of business for your former employer (trust me, I run a business) since the employer’s rates are affected by your claim. Additionally, since unemployment benefits are being strained right now, many states, like New York and Utah, are aggressively pursuing fraud claims. If you are caught accepting unemployment compensation while you are actually working, you could be prosecuted. Most states will require that you repay the overage plus a substantial fine. You could be required to perform community service, be placed on probation and in some cases, you could be jailed. You could be also disqualified from further benefits for a period of time.

On the tax side, I always advise compliance. In your case, you are required by law to produce your Social Security number to your former employer and properly report the income on your taxes. I would suggest that you immediately contact an lawyer that focuses on unemployment compensation and get some good legal advice about your repayment and reporting options on the UC side. You don’t want to make a bad situation worse. Good luck!

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

Hey taxgirl, if I’m a freelancer, buy a desk/chair and try to deduct it is that like begging for an audit? Advice on what to deduct/not?

Taxgirl says:

First of all, I’m psyched! This was my first taxgirl question via twitter! How exciting!

And now for the answer! The short answer is yes, deduct away.

Working from home or freelancing is tough because you have to supply everything yourself – from furniture to computers to office supplies. You are also responsible for your own benefits, such as health insurance. But the good news is that because you have to spend money to make money, these things are deductible.

The easy way to get started with deductions is to walk through your day and take stock of all of your expenses – from post-it notes to train tickets. Ask yourself which of these expenses you would NOT be responsible for if you weren’t freelancing or working from home… You wouldn’t include meals, for example, because you have to eat, working or not. But you would include business cards, computers and the like. A good rule of thumb then, is to think about what is “ordinary” and “necessary” for you to operate your business (those are the terms that the IRS likes to use) and start your deduction list from that point.

With respect to an audit, you should feel free to be aggressive but not greedy. If you feel that you can justify an item as a business expense – your groovy new iPhone for example – then document it appropriately and claim it as an expense. But those pumpkin lattes to get you through the day? They don’t count. I like to use the “laugh test” – can I say it out loud with a straight face? If I can’t, or if I feel the need to add a lot of “but” and “because”, then it’s likely not a reasonable expense.

You can read more about working from home and taking deductions here. You can also download my popular post on Tax Deductions That Bloggers Often Overlook here” – while it’s targeted to bloggers, many of the deductions also make sense for writers, freelancers and others who work from home.

You can also find more information about pro-rating your home office here.

Be sure, however, before you start piling on the deductions, that you’re taking appropriate deductions in the pursuit of a business and not a hobby. Occasionally writing for fun, selling crafts that you make – and even Mary Kay – may actually be hobbies and not business pursuits. A business doesn’t have to be incorporated to be a real business – but you must run your business like a business.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

Good Morning:

My wife was working for a local music school teaching lesson for only a couple of months last year. She was paid a total of $120.00 for 2007. The Music store has not sent us a 1099-MISC form. How do I declare this income on my 1040 form? Do I still have to fill out a schedule C and SE Form to declare this income or can I just insert this amount of money as misc. income?

Thanks for you help.

Taxgirl says:

The music school was not required to issue a form 1099-MISC because the aggregate amount paid out was less than $600.

You don’t need to report this on a Schedule C – you can just report it as other income (line 21 on your form 1040).

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

I left my job as an editor at a media company, but continue to do some freelance work for them. When I submitted an invoice, I was told that for tax purposes I couldn’t be paid by them as an independent contractor in the same year that I was an employee. This means those invoices have 45% taken out for withholding taxes, which I assume means they were treated like bonus checks. But they weren’t bonuses, they were my income, and now come tax time, I’m not sure how to account for this on my Schedule C. I don’t know anyone else who has run into this problem–is their policy legitimate or are they just trying to make my life difficult?

Thanks for any advice you may have!

Taxgirl says:

Your company is kind of right. It is possible to be classified as an independent contractor and an employee by the same payor in the same tax year – but it is unusual. The IRS frowns on it because if you’re doing the same kind of work, it’s hard to argue that your status has really changed.

That said, it sounds like the company has chosen to continue to treat you as an employee. If true, you should have received a form W-2 that includes that income and that withholding – include that as normal. If not, then you should have received a form 1099 with withholding reported – include that information on your Schedule C.

If you did not receive any reporting forms, you need to contact the company. If they won’t issue a proper form, then you need to contact the IRS. You may want to read my prior post on the subject.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

Hi,

I have a question, I’m hoping you can help me resolve my issue.

My husband recieved a 1099 Misc form as his only source of income, but we have be told that he has to file as self-employed been he has to file a Schedule C form, but our conflict is that it is not his dump truck and he does not generate any expenses being he is only an employee.

I hope you can help me resolve my doubts.

Taxgirl says:

Hmm. Obviously, without knowing more specifics, I can’t tell whether your husband is being properly classified or not. But I will say this: it sure sounds like he’s more of an employee than an independent contractor. And here’s why…

The IRS broadly defines an independent contractor as one who has “the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result.”

So red flag #1 for me is that you state that your husband does not own the tools that he uses for his job (the dump truck belongs, I’m assuming to the person that pays your husband).

Red flag #2 for me is that you state that your husband has no expenses associated with the job. Most independent contractors have expenses as they provide their own equipment. The IRS considers expenses a factor in classification of workers as independent contractors, querying the extent to which the worker has unreimbursed business expenses; the extent of the worker’s investment in the facilities used in performing services; and the extent to which the worker can realize a profit or incur a loss.

Other factors would include whether your husband makes himself available to other potential businesses (I’m guessing no since he doesn’t own the truck) and what kind of benefits and expenses, if any, are paid by the hiring business.

I would suggest that you contact a tax professional to discuss your circumstances and make sure that you’re being classified properly.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

I have a question regarding a 1099 or rather a lack there of. I did independent contractor work for a company and they have not issued me a 1099 for 2007. I have a friend who did work for them in years prior and they never issued her one either. Do I report the money I earned on my taxes?

Taxgirl says:

Yes. Assuming that you are a US taxpayer, you must reported all income received, regardless of whether a form 1099 or W-2 was issued.

For more information about forms 1099, see my prior post on the subject.

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.

Taxpayer asks:

I do side work occasionally during the year. It is in the construction industry. I pay people to help me do this work and it is usually under $600.00. I am the one who gets 1099’d and would like to know if I can deduct what I pay these people. I have cancelled checks to prove that I have paid these people. Any help would be appreciated.

Taxgirl says:

You can absolutely deduct what you pay your subcontractors! There is no requirement that you issue a 1099 in order to deduct expenses for workers.

Hopefully, you’ve kept good records to substantiate your payments. You can deduct those payments as expenses on your Schedule C, where you would also report your income as reported the forms 1099 that you’ve received (as well as other income not that you might have received and was not reported on a 1099).

Before you go: be sure to read my disclaimer. Remember, I’m a lawyer and we love disclaimers.
If you have a question, here’s how to Ask The Taxgirl.