Is It Better to Be Taxed as an Employee or Independent Contractor?

tax forms with pencil


From the Oblivious Investor, Mike Piper discusses the differences in taxes for independent contractors and employees.  Mike writes:

So What Are the Tax Differences?

From a tax perspective, there are both pros and cons regarding the tax treatment for independent contractors as compared to employees.

As an employee, you are responsible for paying Social Security and Medicare taxes in the amount of 7.65% (2.9% for amounts beyond the current Social Security earnings limit), and your employer pays a matching amount. As an independent contractor, you have no employer, so you get stuck with both halves of the bill (in the form of a 15.3% self-employment tax).

Another disadvantage of being an independent contractor is that it requires somewhat more administrative work. You’ll have to fill out Schedule C along with your Form 1040 every year to calculate the profit or loss from your business. In addition, because nobody will be withholding taxes from your income, it will (in most cases) be necessary for you to make estimated tax payments throughout the year.

On the other hand, one advantage of independent contractor tax treatment is that your work-related expenses will be business expenses, which will save you money on income tax as well as Social Security and Medicare taxes. In contrast, as an employee, unreimbursed work expenses are generally itemized deductions, meaning that you get no value from them if you use the standard deduction each year. In addition, they’re in the category of itemized deductions from which you must subtract 2% of your adjusted gross income before even being allowed to include them as an itemized deduction. (See theinstructions to Schedule A for more information.)

An additional advantage of being an independent contractor is that you’ll have additional retirement plan options available to you. Most importantly, you’ll be eligible for a solo 401(k) — alternatively referred to as an individual 401(k) — for which the contribution limits are quite high.

Read the full story at Is It Better to Be Taxed as an Employee or Independent Contractor?

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