Q Dear Rick:
I have been unemployed for a couple of years now and I was just offered a new job. It is basically the same type of job I had before, although I would not get any benefits. On my first day I had to sign a variety of forms and one of the things that I signed was an agreement saying that I was an independent contractor and not an employee. When I asked about that I was told that it doesn’t mean that much and the only difference is that as opposed to them withholding my taxes, I would have to do that myself. My question is did I make a mistake by signing this document and in addition, is there anything else that I should know?
A Dear Ron:
In reviewing your situation, the first thing you should know is that there is a difference between being an employee and an independent contractor. As an independent contractor, you are your own business and as a result, you don’t have the same rights granted an employee. For example, as an employee, if you lose your job you’re entitled to unemployment. It is not that easy to collect unemployment as an independent contractor. In addition, as an employee in most businesses, you receive paid vacations. That is not the case with an independent contractor. The bottom line, the relationship between you, an employee, and your employer is totally different than the relationship between an independent contractor and the company.
From a tax standpoint, what they told you was correct but it’s not the whole story. As an employee, if you were paid $1,000 a week, the check you receive from your employer at the end of the week would not be $1,000. It would be $1,000 less federal and state withholding taxes and Social Security. On the other hand, if as an independent contractor you’re entitled to $1,000, your check would be for $1,000. You as your own business are responsible to make estimates for your state and federal withholding. In addition, you are also responsible for Social Security. As an employee, your employer would withhold 7.65% from your check for Social Security and Medicare. In addition, your employer matches those amounts. On the other hand, when you are an independent contractor, you’re treated as self-employed and thus, you are responsible for both the employer and the employee ends of Social Security. Your rate is 15.3% for the first $118,500. Therefore, what you may discover is that being an independent contractor substantially raises the amount that you are paying into Social Security.
There are some benefits to being an independent contractor and one of them is that you are allowed to deduct expenses. Employees have a much more difficult time deducting expenses versus an independent contractor. Therefore, if you have substantial business expenses, it is much easier to deduct those for tax purposes than if you were an employee. Furthermore, as an independent contractor you can establish your own retirement plan which may allow you to contribute more than you could in your 401(k) Plan.
The reason why many companies want to classify someone as an independent contractor versus an employee is so they’re not responsible for employee related costs such as the matching of Social Security, federal and state unemployment taxes and employee perks such as healthcare. That does not mean that because it’s good for the employer it’s not also good for the independent contractor. However, in many situations the individual as an independent contractor ends up paying more in taxes.
If you accept a position and become an independent contractor, it is important to make sure you pay your taxes on time. Many people think taxes are due April 15 but that would not be correct. April 15 is when your tax return is due. The payment of taxes is done on a quarterly basis. Therefore, it is important for those of you who become independent contractors to make sure you make timely quarterly payments, not only to the federal government, but also to the State of Michigan.