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Major life milestones often have a major tax impact. Changes in your marital status, having a baby or adopting a child can have significant impact on your taxes. This is the place to ask questions about dependents, real estate, and other various scenarios that play a significant role in what taxes you pay.

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Valued Pioneer
Posts: 3
Registered: ‎05-18-2017
Accepted Solution

Taxes -- "self employed" or "other income"?

I recently changed jobs and my pay is split between a W2 and a 1099 from two private companies, but the two are related companies (=same boss). Both the W2 work and the 1099 work I do is technical, and requires laboratory space (not a work-from-home situation) and all the equipment I need to be provided by my contracting company. Because of this, I have no deductions for the 1099, so when I calculated taxes on it, it came out to a whopping ~30% (on ~30k).

 

One of my colleagues in a similar situation was instructed this past year by her tax preparer to file this as "other income" since she is arguably not "self-employed" in that her work space and materials must be provided by the company contracting her. Is this acceptable to do? I calculated my numbers as such and it came out to about 18% in taxes, which is much more in line with the ~15% I was expecting to pay when I accepted this job. 

 

All guidance is appreciated! I haven't been able to get a straight answer from anyone and will definitely need to renegotiate my salary if I need to file as "self-employed."

Tax Pro
Posts: 5,615
Registered: ‎02-23-2016

Re: Taxes -- "self employed" or "other income"?

Hi makitoes,

 

Welcome to the H&R Block community.

 

This happens to be one of my areas of expertise and I'll be glad to shed some light on the 1099-MISC and how to report it for you.

 

The tax preparer who instructed your friend to report their 1099-MISC income as "other income" is wrong, and if your friend does that they will receive a letter from the IRS informing them that they owe a significant amount of additional tax, interest, and penalties.

 

Forms 1099-MISC with income shown in Box 7 are issued to independent contractors.  What that means is that you are not being treated as an employee for tax purposes, and therefore your employer doesn't have to payroll taxes on your income at the state or federal levels.  In other words, you are being treated as a self-employed contractor for tax purposes.

 

1099-MISC income must be reported on SCHEDULE C except in fairly rare circumstances where the income reported on the 1099-MISC is rent reported in Box 1 or an award amount reported in Box 3.  When you complete Schedule C you can deduct any unreimbursed expenses you incurred for your job from the 1099-MISC income.  Your net income (gross income less expenses) is taxable for the federal income tax, the social security tax, the Medicare tax, and the employer's part of the FICA (social security & Medicare) tax.  So your taxes end up being:

 

  • 7.65% employee FICA tax (6.2% social security & 1.45% Medicare)
  • 7.65% employer FICA tax (6.2% social security & 1.45% Medicare)
  • 5-10% federal income tax (which may be less if you're eligible for tax deductions and/or credits or if you earned below your filing requirement or it may be more if you're in a higher tax bracket).
  • State income tax which is somewhere between 2% and 10% in most states (if you live in a state that imposes an income tax).

 

The federal income tax can be reduced by numerous tax benefits, but the FICA taxes can only be reduced by refundable credits or excess W-2 withholdings from another job.

 

Part of the difference that you're no doubt experiencing is that you don't have any tax withholdings.  As a W-2 employee, you have about 10% withheld for the federal income tax, 6.2% withheld for the social security tax, and 1.45% withheld for the Medicare tax, and your employer pays the other 6.2% and 1.45% of the social security & Medicare taxes out of their own pocket.  As a W-2 employee you also normally have your state income tax withheld.  The key to being an independent contractor is knowing how much to set aside for taxes so that you don't end up owing tax at the end of the year.

 

If you have any other questions I'll be glad to help.

 

Louis,

Senior Tax Advisor (Tampa, FL)

Valued Pioneer
Posts: 3
Registered: ‎05-18-2017

Re: Taxes -- "self employed" or "other income"?

Hi Louis,

Thanks so much for the numbers and clear breakdown! Your explanation makes a lot of sense. I'd like to ask another question so I can go into negotiating my salary or shifting my responsibilities since the work is flexible between the two jobs.

If I calculate how much I took home (Box 1 on my W2) vs Box 1+2+4+6 (=pre tax amount if I am not mistaken), I get approximately 85%. If I owed nothing at tax time, I would have paid about 15% to federal and state taxes.

How or why does this vary so much from the self employment tax which is 25-30% when SS, Medicare, and federal income is added up? Why is a W2 taxed at such a dramatically lower tax rate than a 1099? (If it helps or matters at all, all these numbers are between 25 and 50k.)

Again, I appreciate your time!
Tax Pro
Posts: 5,615
Registered: ‎02-23-2016

Re: Taxes -- "self employed" or "other income"?

[ Edited ]

makitoes,

 

You're quite welcome.

 

With a W-2 your pre-tax paycheck amount is Box 1 and your pre-tax total amount is reported in both Boxes 3 and 5.  Boxes 1, 3, and 5 will all be the same if you don't have any pre-tax items such as retirement contributions taken out of your pay.

 

Boxes 2, 4, and 6 are your taxes.  When you have a W-2 you don't have to pay the entire 15.3% on the social security & Medicare taxes yourself.  Approximately 7.65% of that comes out of your pay (Boxes 3 and 5) and that's the biggest part of the difference in the numbers.  If you add in the employer part of the FICA tax to what you see on your Form W-2 you would be paying over 25% of your income in taxes so that's the biggest difference.

 

The federal and state income taxes are the other variable.  For a W-2 employee the federal income tax is withheld at a rate of between 1.5% and 10% depending on how you filled out your W-4.  I always estimate tax for people using the max of 10% so that I know those I'm helping will withhold enough no matter what, but if you claimed exemptions on your W-4 your federal and state withholding will be less.  Remember though that your tax liability for both the federal and state levels is officially determined on your tax returns and may be more or may be less than what you see on your W-2 depending on your credits, deductions, etc.  The best way to figure what your federal income tax will actually be is to use a tax calculator, such as the H&R Block tax calculator, to determine the expected outcome of your return.

 

If you're going to negotiate your pay, the easiest thing to do would be to ask your employer for an extra 7.65% of your income to cover the employer half of the self-employment tax and that will reduce what you pay out of your paycheck to around 15 to 18% instead of 25 to 30%.

 

Note that as a 1099-MISC contractor you get a deduction for 1/2 of the self-employment tax directly on the 1040, but it does not reduce your tax liability dollar for dollar.  It reduces your taxable income for the federal income tax and may reduce the federal income tax by a small amount.

 

Louis

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Valued Pioneer
Posts: 3
Registered: ‎05-18-2017

Re: Taxes -- "self employed" or "other income"?

Got it, I will look into the numbers just to make sure they match up. Taxes feel so overwhelming (and mine aren't even complicated by comparison to many) and it's been great to have it broken down for me. Thanks for your replies!