In today's economy, more and more people find themselves working a second job, which can bring a new twist to their tax situation.
Or sometimes after having been downsized, workers who can't find full-time employment will work a number of independent contractor positions to bring money in. Or you may be dipping your toes in the self-employment pool to test the waters before taking the plunge to full-time self-employment.
Get Help if You Need it
Whatever the reason, soon after the first of the year, you find yourself getting IRS forms 1099-MISC in the mail. If you didn't expect to be classified as an independent contractor rather than employee, you may be in a tax situation you have never faced before -- and may be looking at a larger tax debt than anticipated.
The extra tax obligation comes from the fact that, when you are an employee, your employer pays half of your Social Security and Medicare taxes -- the amount withheld on your W-2 is your half only. As an independent contractor, not only do you pay twice as much as an employee, nothing will have been withheld from your pay to cover these items. You have to pony up the whole amount at tax time.
If there is a possibility you took on a second job under the assumption you were an employee, not an independent contractor, then the first thing for you to do is figure out whether you truly are an independent contractor or an employee.
Just Because Your Employer Calls You a Contractor Doesn't Make it So
The person paying you may classify and pay you under a few different scenarios:
- independent contractor
- common-law employee
- statutory employee
- statutory non-employee
According to the IRS, the general rule is that you are considered an independent contractor if the person you're working for has the right to control or direct only the result of the work, not what will be done nor how it will be done. In other words, if you want to sit in front of your computer in your underwear at 2 in the morning and knock your work out, the person who is signing the check can't tell you to put some pants on.
What the IRS Mean
Here is an example: Emily Avers, an electrician, offers to do a job involving electrical work at $16 per hour for 400 hours to an apartment complex. The offer is accepted, and she is paid $1,280 every two weeks for 10 weeks. This is not the same as being an hourly employee. The bid is for the completion of the job, and if she gets it done in more or fewer hours she will still get $6,400.
She also performs additional electrical installations under contracts with other companies, rather than working only for one employer. That's another indication that Emily is an independent contractor.
Withholding for Taxes
In general, when it comes to earnings in the case of employer/employer relationships, employees have amounts withheld for income, Social Security and Medicare taxes. The employer will also pay unemployment tax on those wages.
No deductions are withheld for income, Social Security and Medicare taxes in the case of independent contractors, and there is no employer contribution for those amounts. It costs less for an employer to classify a worker as a contractor instead of an employee, and employers have been known to do this when they shouldn't have. If you think you should be counted as an employee rather than a contractor, check with the IRS. Tax Topic 762 covers this in detail. If an employer misclassifies an employee, the employer can be held liable for employment tax debt and penalties.
If, as an independent contractor, you received $600 or more from a payor for services rendered, you will be issued a Form 1099-MISC, Miscellaneous Income.