Classification of Workers Changed; Are you an employee or an independent contractor?

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In the past, independent contractors had to pay more taxes compared to those workers classified as employees, but this may no longer be the case. With the Tax Cuts and Jobs Act passed in 2017, claiming to be an independent contractor may be more beneficial when filing your returns.

Before you decide to jump into transitioning your classification, keep the following definitions in mind:

•  If the business has the right to tell you what, when, and how to do your job, you are an employee, not an independent contractor
•  If you are not in charge of the business aspects of your job and are not feeling the business stress and pressure that a business owner would feel, you are probably not an independent contractor.
•  If you are not free to work wherever you please and whatever hours you deem fit, you are not an independent contractor.

After reading those parameters if you think you might be an independent contractor, you should know that there is a new 20% income deduction available for business owners of S-Corporations, LLC’s and partnerships and also independent contractors filing Schedule C! The deduction is either 20% of qualified business income (QBI), net of business expenses, or 20% of the difference between taxable income prior to the deduction and any capital gains, whichever is less.

There are limitations to be aware of, however. If your taxable income before the 20% reduction is greater than $157,500 filing as an individual or $315,000 married filing, there are some income limitations applied such as wage and property limits and the service business limits. Professional service businesses such as lawyers, accountants, brokers, insurance firms, investment managers, etc. are subject to this taxable income limitation. Most other service businesses are not subject to this. The IRS recently issued clarification of which professions fall into this undesirable category.

For example, a W-2 employee who earns wages of $100,000 per year.  Compare this with an independent contractor whose contract is for $100,000 plus additional compensation for “gross up” of the social security and Medicare taxes on $100,000 of self-employment income ($100,000 plus $7,650 equals $106,750).

Gross income for the employee is $100,000, the self-employment tax deduction is $0, and the standard deduction is $12,000, which leaves the employee with $88,000. Because the employee is paid wages, the 20% pass-through deduction is $0, making his or her taxable income $88,000, resulting in income tax of $15,300.

For the independent contractor, his/her gross income is $107,650, the self-employment deduction is $7,605, and the standard deduction is $12,000, leaving the contactor with $88,045. Based on the 20% pass-through deduction of $17,609, the taxable income becomes $70,436 and federal income tax amounts to $11,435.

Now, for the employee, based on the above calculations gross income – Income Tax – Social Security & Medicare Tax = $77,050 of federal after-tax income.

For the independent contractor, based on the above calculations gross income – income tax – self-employment = $81,005 in after tax income (107,650-$15,210 self-employment tax-11,435 income tax).

As you can see, working as an independent contractor saves the filer $3,955 in after tax income!

However, there are consequences for classifying and filing incorrectly, including being held responsible for all back payments of both the federal and state payroll taxes, unemployment taxes, and employment benefits.

We at Mazur and Associates suggest that if this is something you are considering, you should have a written contract. The independent contractors should retain an attorney to review all documents, and if necessary, contact the IRS for help in choosing a filing status for form SS-8 (Determination of Workers Status for purpose of Federal Employment Taxes and Income Tax Withholding). But above all, we urge you to call our office and set up an appointment! We can thoroughly review your options, including the advantages and disadvantages of each compensation classification, and explore the best and most sensible options for your particular situation. We are available Monday through Friday at 8:30 AM to 5:30 PM at (732) 936-1230.

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