Independent Contractor Versus Employee

So now you are making money on the internet. You never thought it would happen. But later this year, you received the tax bill for doing well. Your happiness turned to gloom. We will explore some personal money management facts that may have helped you avoid some unpleasant situations.

Contractor Versus Employee

When you have your own business and perform services for customers, you are not an employee anymore. This is because you have complete control over how and when the services are performed and for what fee. By definition, you are an independent contractor. What does this mean? Well, if you do not have a business structure (i.e. corporation, partnership, limited liability company) in place, you are responsible for being both employer and employee. This entails paying all the taxes due on any money earned.

Simple Example

As a work from home mom, you are a proof editor and fix articles for people for a fee. For this example, we will say you have no expenses at all, but just receive fees only. You are paid $100.00 this week. Currently in 2011, 15.3% of that hundred dollars, or $15.30 is due to the federal government to cover social security and medicare taxes. And it is due now. If you wait until yearend to pay all your taxes on self-employment income, you may be subject to penalties. See penalties in the section below. And you have not even covered any state unemployment taxes, federal unemployment taxes or federal income taxes due on that money.

Penalties

A self-employed person is required to pay estimated taxes on a quarterly basis. If you do not, you will incur a penalty. For instance, your tax liability for the year (incurred evenly throughout the year) is $4,000.00. The taxes were paid on December 31st. But one fourth or $1,000.00 was due during the first quarter, another fourth was due during the second quarter and the third fourth was due during the third quarter. Even though the taxes are paid, you are late for the first three quarters, and a penalty will be calculated for the late payments using an interest rate set by the government that is adjusted periodically.

Why 15.3%?

You may recall that, as an employee, your social security and medicare taxes were not 15.3%. That is because, as an employer and employee, you are responsible for both employer and employee portions of the taxes. That’s right, your employer had to match your taxes all those years.

Unemployment Tax?

Only employers are obligated to pay state and federal unemployment taxes on wages. This is why you may never have heard of them before.

A Step Back

As a business owner, you probably know you are allowed to deduct expenses incurred in the production of taxable income. We will now look at that same $100.00. Your expenses may have totaled $30.00. Right away, you are down to $70.00 before you pay taxes. Have you set up a retirement plan for yourself? The costs to contribute to the plan are deductible, as well as any contributions the business makes for you, the employee. Notice we said business makes. Next lesson, explore what kind of business forms are available to you and if any are right for your business. And learn how to manage money better to take advantage of all the tax breaks available.