GRAND RAPIDS, Mich. — There are financial benefits that come from being an employee versus an independent contractor. If you're in the position to chose which route to take, what is the best option?
Smart Money expert Chris Harper shares the financial considers for both roles and some advice as to which may be better suited for the situation/person.
Employee vs. Independent Contractor
Employees will receive Forms W-2 from their employer(s) showing wages and withholdings for the year. Employers are required to withhold income taxes, Social Security, Medicare, and unemployment taxes.
Independent contractors are self-employed. Independent contractors are responsible their own tax filings and payments. Independent contractors pay both income and self-employment taxes on their earnings
The 15.3% self-employment tax represents the full Social Security and Medicare tax obligations that would otherwise be divided between the employee and employer in an employee-employer scenario.
Taxpayers classified as independent contractors may not realize their status until they file for unemployment benefits, seek a worker’s compensation claim, or are hit with an unexpected year-end tax bill.
Tax Treatment of Expenses
Employees
- Out-of-pocket expenses are not deductible under current tax law.
- However, an employer may reimburse work-related expenses tax-free under an accountable plan.
Independent Contractors
- Ordinary and necessary expenses of your business will often be deductible. This is an illustrative, non-exhaustive list of possible deductions.
- Materials, tools, supplies, and uniforms
- Health insurance premiums
- A home office deduction if you qualify
- The portion of your cell phone bill used for business purposes
- Vehicle expenses (either actual expenses or 58 cents per business mile driven in 2019)
- Many other possibilities exist.
Independent Contractors in the Real World
The Popularity of Ride-sharing and Third-party Delivery Services
Taxpayers are participating ride-sharing and third-party delivering services and are treated as independent contractors.
The income earned in these jobs will be subject to both income and self-employment tax -- and taxpayers will likely file Schedule C with your Form 1040. Include the revenue derived from the business (you are still responsible for reporting the revenue you earned even if you did not receive a Form 1099.
Deduct qualifying expenses associated with your ride-sharing or delivery service business. Since no employer is withholding tax from your pay, you will need to consider the need to remit estimated payments.
Practical Considerations
Obtain clarification regarding your status at the outset of your employment relationship.
Employees should periodically assess their withholding, and file a revised Form W-4 with their employer as needed.
Independent contractors will need to assess the amount and timing of estimated tax payments to the United States Treasury, State of Michigan, and/or a municipality (some cities impose an income tax).
Independent contractors should seriously consider hiring a CPA to assist with quarterly estimated payments, income tax compliance, and overall income tax planning.
Information courtesy of Chris Harper, CPA, MBA.
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