Whether you prefer the term gig economy or sharing economy, the feel-good language can obscure one major shift that the new economy has ushered in. Today’s workers are significantly more likely to be classified as contractors than as an employee. While many workers may be tempted to discount this difference in their rush to start working for a company like Uber or Lyft, classification as a contractor has significant effects on your tax liability and other aspects of the work you perform.
Perhaps most poignantly, contractors who participate in the sharing economy are simply gobsmacked by the amount that the IRS says they owe when they file their taxes. They may think that it is merely a mistake or error. Unfortunately, if you are working as a contractor in any capacity, you may join the legions of individuals shocked and upset by their income tax bills. Contact a Sacramento tax lawyer of NewPoint Law Group, LLP for more insight on your taxes today.
A Note about the Recent Decision in Uber v. Berwick (2015)
Many people have likely heard about the litigation regarding the classification of workers as employees or contractors in California. While it is true that the California Labor Commission found that an Uber driver in California is an employee and not a contractor in the state, the ruling is limited to only this single driver for the time being. It may open the door to a potential reclassification down the road; although, Uber is currently appealing the decision. For the time being, most Uber drivers are still being treated as contractors and still face the issues that other contractors face.
What Is the Difference Between a Contractor and an Employee?
There is an abundance of distinctions in treatment between an employee and a contractor. For the purposes of this article, we will focus solely on the differences in tax treatment. To start, employees are issued a W-2 at the end of the tax year while a contractor is issued a 1099. During the year an employee will probably notice (and possibly complain about) the numerous withholdings from his or her check. He or she is likely to see a federal income tax deduction, state unemployment insurance deductions, and Medicare and Social Security taxes (FICA). By contrast, a contractor will not have these deductions on his or her paycheck.
Since contractors do not have these deductions, they often end up paying the full amount when they file a tax return. However, when a contractor is self-employed for a long period of time, he or she may be required to make estimated quarterly tax payments or face a penalty.
In an employer-employee relationship the business owner pays a portion of the employees’ Social Security and Medicare tax obligation. This does not hold true for contractors; rather, contractors are required to pay a self-employment tax. The self-employment tax includes the same Social Security and Medicare taxes an employer would pay. In other words, this means that the contractor can face a large tax obligation come tax day.
Contractor Status Can Mean That You’ll Face a Large Tax Bill
To further expand on the previous statement, if a contractor did not arrange to make quarterly estimated payments, he or she could face a potential tax bill in the thousands of dollars. For instance, a driver or contractor who makes $50,000 in a year could owe $6,000 or more in taxes at the end of the year. If he or she failed to budget for this tax bill or make payments throughout the year, the seemingly sudden demand for more than $5,000 could be catastrophic. Additionally, if the driver failed to keep meticulous records on business use of a vehicle versus personal use, then deductions and other tax minimization strategies may not be available.
In short, entering into the gig economy is marketed as an easy and fun way for people to make money. Despite this sentiment, what should really be emphasized is the fact that you are essentially becoming a business owner with all the associated responsibilities and duties. If you are working as a contractor and haven’t thought about budgeting for taxes, quarterly tax payments, logging and tracking expenses, and other concerns business owners must consider, we encourage you to speak with a tax professional immediately.
Work with a Sacramento Tax Lawyer if You’re a 1099 Contractor
Contractors who have failed to consider the tax consequences of their activities should speak with a tax lawyer as soon as possible. If you are facing a large and seemingly unmanageable tax bill, a Sacramento tax attorney of NewPoint Law Group, LLP may be able to help you work out a payment plan with the IRS, or take other action on your behalf. They can also help you make arrangements to avoid a tax bomb in the future. To schedule a confidential consultation, call 800-358-0305 or contact us online today.