UPDATE: Please see the 2015 version of this post here.
When I was in college, I had a great job. It paid what was then a queen’s wage of $6.00/hour, all my friends had the same job, I got to be outside a lot, and I learned a skill that I can still use today. We were on a paint crew as independent contractors. We received a check each week, and after the end of the tax year we received an IRS Form 1099-MISC.
When you’re 20 years old and being paid a queen’s wage, you don’t think about these things too much. It doesn’t occur to you to stop and say, “Wait. $6 x 40 hours = $240. That is the amount of my check. Sooooo, I guess no taxes were withheld.”
Instead you’re thinking about how many cigs and beer that $240 is gonna buy. (Fracking LOTS, back then. Which seemed awesome.)
But the problem is that on the paint crew, we actually weren’t independent contractors.
Independent contractors earn their living from their own businesses. They typically work for a number of different clients or firms, and they’re also known as consultants, subcontractors, freelancers, self-employed people, or small business owners.
No, we were actually employees, expected to show up at the same time every day. The boss provided our brushes, paint, ladders, and other tools. Besides the extent to which we were maybe risking our lives hanging from scaffolding 50 feet in the air, we didn’t have anything invested in the painting business.
This particular employer was
pretty much lying to us taking advantage of our 20-something naivete to get away with not paying the employer share of FICA (also known as the Federal Insurance Contributions Act, or the funding source for Social Security & Medicare).
Why does this matter?
When you work as an independent contractor (meaning: you’re self-employed), you’re required to pay income taxes just like an employee. Unlike an employee, however, there are no taxes withheld from your paycheck. Instead, you must pay estimated taxes four times a year.
Also unlike an employee, the person for whom you’re working doesn’t have to pay one-half of FICA. You have to foot the entire bill. There are many awesome things about not working for The Man. But paying the full 15.3% of FICA (or self-employment tax, as it’s also known) is one of the major bummers of being self-employed.
How do I know if I’m an independent contractor or an employee?
It’s really up to you and the hiring firm or client to decide whether you should be classified as an independent contractor or an employee. But the IRS has developed a few questions with the intention of providing a clearer picture.
- Are you required to comply with instructions?
- Is there a continuing relationship?
- Are there set hours of work?
- Is there a full time work requirement?
- Is the work done on the premises of the business?
- Is the order or sequence of the work established?
- Does the hiring firm or client provide your tools and materials?
If you can answer “yes” to these questions, most likely you’d be considered an employee in the eyes of the IRS.
This is good news for you in the sense that you should receive a Form W-2 from your employer, not a Form 1099-Misc. The familiar Form W-2 displays (among other things) wages earned and taxes withheld, including those withheld for FICA.
On the down side, you (probably) can’t just show up to work at noon in your pajamas.
You’re more likely to be classified as an independent contractor if you:
- Can earn a profit or suffer a loss from the business
- Furnish your own tools and materials, and invest in your own equipment
- Are paid by the job (versus by the hour)
- Are able to work for more than one firm or client at a time
- Pay your own business and traveling expenses, and
- Set your own working hours.
In this case and assuming you earned more than $600 from the payer, you should receive a Form 1099-MISC, which displays non-employee compensation in Box 7.
What you should do
Reach a mutual understanding with your client or firm about your job duties. A written agreement helps establish that you actually are an independent contractor and not your client’s employee. (Not only that, accepting a project on nothing more than a handshake is never a good idea. Specify in writing every last parameter and expectation–from revisions to deadlines and payment dates–so that you can avoid negotiating these details at the end of the job.)
More importantly, start planning early. If you’re self-employed, you need to keep fairly scrupulous records of your income and expenses, and you’re singularly responsible for paying estimated taxes throughout the year. Talk with your accountant, or read IRS Publication 583.