Pros and Cons of Contractor Taxes

  • Contractor Tax

Are your salaried friends paying less than you in taxes despite making more money?

 Welcome to the world of the 1099 contractor.  One of the phrases the cool kids are all using to talk about the state of the US is “gig economy.”  The costs to have full-time W-2 employees on staff have gone up, and a lot of companies have responded by cutting back on full-time staff in favor of 1099 independent contractors.  How “independent” these contractors actually turn out to be is up for debate, but what isn’t up for debate is how much the IRS is expecting them to pay in taxes.  Here are four quick points about 1099 taxes.

  1. (almost) EVERYTHING is deductible: As a 1099 contractor, you are considered to be self-employed. As such, you and your business are the same tax-paying entity, which means the stuff you’re spending on yourself that relates to your work can be deducted from your taxes as business expenses (as expected, there are various rules and regulations, so consult your friendly neighborhood CPA / Tax Attorney).
  2. Remember to Pay: If you are a W-2 employee, your basic taxes get taken out of your paycheck every pay period and mailed off to the government. Come the end of the year, you tell the IRS how much you have already paid and then you find out what the balance on your account is.  For a 1099 contractor, nobody is paying taxes for you, which means you need to remember to set aside a portion of your income to pay these taxes.
  3. Estimated Tax Payments: According to the IRS website, “If you are filing as a sole proprietor, partner, S-corporation shareholder, and/or a self-employed individual, you generally have to make estimated tax payments if you expect to owe tax of $1,000 or more when you file your return.” This means that if you expect to earn more than $10,000, the money you were setting aside needs to go to the IRS on a quarterly basis.  If you go to their website, there are all kinds of tools to figure out how much you should pay and how to do it on a quarterly basis.
  4. Side-effects Include Double Taxation: W-2 employers pay for Social Security and Medicare, and then they withhold the same amount from the paychecks of their employees. As a 1099 contractor, you have to pay both the employer and the employee portions of this tax.  In 2017, this is 15.3% on the first $118,500 of net income and then 2.9% on additional net income.  You can claim the employer portion (7.65%) as a deduction on your tax return, but you still have to pay it in advance.
  5. Some of these things can get rather complicated, so please, please, PLEASE consult with a tax attorney and/or CPA to figure out what is best for your situation.  Not sure who to use?  Contact us directly for a referral.Matthew Vitlin is a Fee-Only financial advisor with Reliant Wealth Management. He helps individuals and families from all walks of life start, grow and manage long-term investment portfolios.

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About the Author:

Tim Plachta, CFP® owns and operates Reliant Wealth Management and Reliant Consulting Partners.  He works primarily with small business owners to help them increase profit, reduce their workload (so they can relax more), and invest enough of their earnings to achieve financial independence.