From W-2 to 1099Misc

I will get back to my education series after the 15th but just a quick reminder based on a phone call I received this morning.

With unemployment so high many people are at the point of taking the best job they can find not the the job they want. It has also forced many employers to make cuts in employee benefits and expenses. To save money, many employers have chosen to change wage jobs to contract labor jobs. Whether this is a legitimate change or not is not the discussion here, what I want to talk briefly about is the responsibility of the new contractors. 

If you do take a contract labor job, your taxes will change. The biggest change is you will not be able to rely on your employer to withhold for you. You will have to put aside money from each paycheck yourself. Making this harder is that you will have to hold back even more than disappeared from your employee check.  Let's say you are currently making $800 a week and at the end of the year break about even on your 1040. From your check, your employer will take Federal and State tax withholding of say $100 and your half of Social Security and Medicare of $49.60 and $11.60. This results in a take home of $638.80. But if you take a contract labor job with the same $800 a week payday, you will get a check for the full $800. So you put aside $161.20 a week and you think your taxes are covered. Nope. You could owe over $3000 at the end of the year. A contract laborer has to pay both sides of the the Medicare and Social Security on their 1040. Unless you add another $61.20 to the money you set aside, you haven't taken care of your "employer contribution". Remember you are now both the employer and employee. So, if you take a contract job, be aware that you may actually be taking a pay cut unless you factor in the added self-employment tax expense. 

Also, simply putting aside your tax money for the end of the year is not a good idea. You need to get in the habit of making estimate payments. First, it is too easy to "borrow" from the tax money and too hard to put it back. Then, at they end of the year, the money isn't there to pay your taxes. The second reason to prepay with estimates is that it could save you some money. There is an Underpayment of Estimate Taxes, Federal and most states, that can come into play if you owe too much at the end of the year. So, prepayment can save you some money. Your tax professional can help you set this up.

There are more tax issues when you make the change from employee to contract labor, and I'll cover them soon. But if you are aware of the self-employment tax issue and estimates, you have the knowledge to not get a nasty surprise at the end of the year.