Tired of being a wage slave? Thanks to the Tax Cuts and Jobs Act (TCJA), some disgruntled salaried employees are looking into becoming independent contractors. But before you take the leap into a new way of working, you need to take tax and other matters into account.
"Congress flipped traditional tax-planning upside down" with the new tax law, noted the Tax Policy Center's Steven M. Rosenthal in a TaxVox post soon after the new tax law took full effect earlier this year.
"Many moderate-income workers may be able to exploit a tax break that higher-income workers cannot. And by shifting their status from employee to contractor, workers potentially can reduce their taxes by thousands of dollars," wrote Rosenthal.
Rosenthal is talking about the TCJA's 20-percent individual income tax deduction for income from pass-through businesses such as sole proprietors and partnerships.
This tax law change effectively provides a lower income tax rate on a sole proprietor's income than for an employee with similar income. The dollar details are shown in the Tax Policy Center's comparison below.
Of course, it's a tax law, so it's not that simple.
Neither is it easy to go from employees to contractor, or consultant or whatever title you plan to use under your new tax-favored independent work arrangement.
If you are thinking of quitting your job and becoming an independent contractor, here are some things that the Internal Revenue Service and U.S. Department of Labor say, along with some of my thoughts thrown in there, that you need to think about.
1. Who pays you?
As an employee, you usually work for only one employer.
As an independent contractor, you generally provide consulting services to more than one company.
Considerations: If you like diverse work challenges and dealing with lots of people, contracting should appeal to you. Remember, though, depending on what you do, you might encounter situations where different client needs conflict. Be prepared to juggle. And you're going to have to invoice all those clients and hope they pay on a schedule (or pay at all!) that allows you to pay your bills.
2. How and when you work.
As an employee, you work the hours set by your employer. In most cases, this means working under the control and direction of the employer, including exactly how your boss wants you to complete a task.
As an independent contractor, you work relatively, well, independently. You get to set your own hours and have the authority to decide how to go about accomplishing tasks. It doesn't matter how you get there as long as you get the final job done to the client's request,
Considerations: Again, juggling. If you do most of your best work overnight, as long as you provide what the client wants when he/she wants it, you're fine. You also need to be confident about your ability to meet the client's needs without constant consultation. And remember, if you have lots of clients, get ready to work for much more than 40 hours a week.
3. Where you work.
As an employee, you usually work at your employer's place of business.
As an independent contractor, you work out of your own office or home.
Considerations: If you rent space, you'll need to be able to cover this overhead. If you work from home, you can claim a home office tax deduction as long as you follow the Internal Revenue Service rules.
4. Benefits … or not.
As an employee, you typically receive employment benefits, such as health and disability insurance, as well as a retirement plan where the company often matches a portion of your contributions.
As an independent contractor, you are responsible for taking care of your own health care and retirement contributions.
Considerations: The TCJA eliminates the Affordable Care Act (ACA) penalty for not having minimally acceptable health care coverage, but not until the 2019 tax year. For 2018, the ACA coverage requirement remains in effect. That means you could face a health care tax penalty of the greater of $695 per individual (up to a maximum of $2,085) or 2.5 percent of household income. If you're eligible to claim a penalty exemption, you can file Form 8965 with their tax return.
When you do get self-coverage as an independent contractor, however, in addition to avoiding the ACA penalty, any premiums you pay for acceptable medical insurance coverage are tax deductible. You also can deduct contributions to self-employed retirement plans you establish when you start working for yourself.
5. Paying taxes.
As an employee, you receive a net salary after your employer has withheld income tax and Social Security and Medicare tax under the Federal Insurance Contributions Act (FICA).
As an independent contractor, you must pay federal and state income taxes, as well as FICA taxes yourself.
Considerations: Taxes are pay-as-you-earn regardless of whether you get your income from an employer or as an independent worker. So be sure to budget for your quarterly estimated tax payments. These cover any income tax you owe, as well as the associated self-employment taxes — both the employee and employer portions — that you now much pick up yourself. Fail to do so, or don't make the payments on time, and you'll end up owing penalties and interest.
Don't rush into a job change: Whatever you decide when it comes to how your do your job, make that decision wisely. Yes, being your own boss is a great thing for many folks. But not for all.
An earlier blog post also looks at the differences between being an employee or a contractor.
The IRS also has a special web page dedicated to determining whether someone is an employee or independent worker. Its take is more for the folks doing the hiring, but it gives individuals an idea of the issues.
Business considerations, from the new pass-through deduction to hiring employees vs. contractors to how the new law affects meals and entertainment expenses, also were topics at this week's Twitter #TaxBuzzChat. Check out that hashtag and TaxBuzz's Joann Doan's comprehensive overview of the online tax pros' conversation.
So the bottom line, which is very important to every business owner, is that before you channel Johnny Paycheck, do your homework and make sure you're ready to be the boss and take on all the work that such a promotion entails.
You also might find these items of interest:
- 4 tax tips for independent contractors
- Uber ruling underscores contractor vs. employee conflict
- Small businesses' many new tax considerations, plus some new tax law tips