Contributed by Ben Baker, Professor of Economics
If your employer treats you as an independent contractor (self-employed) instead of as an employee, you need to be aware of a potential tax issue. Employers do not withhold any taxes from the earnings of independent contractors so you will be responsible for paying any Federal income tax, state income tax, and self-employment taxes yourself. That could come as quite a shock next April when you find that you owe several hundred dollars when you file your income tax returns.
The majority of workers are treated as employees, meaning that their employers withhold taxes and remit them to the appropriate governmental agency. Employees receive a Form W-2 by January 31 each year, detailing the amount of taxable income that was earned as well as how much was withheld in income taxes and FICA tax (Social Security and Medicare). If you are an employee, you pay one-half of the FICA tax (7.65% of earned income) and your employer matches that amount (another 7.65%) for a total of 15.3%. If you are self-employed, you will receive a Form 1099. In this case, you are responsible for paying both the employee and employer portions of the tax – the entire 15.3%. This is in addition to any income taxes that you may owe.
Many interns are unaware that they are responsible for paying all of the taxes themselves and are unpleasantly surprised at tax time.
Imagine that you earn $4,000 during your internship. If that is your only income for the year, you will owe no income tax because you are below the threshold for paying those taxes. BUT, you will owe $565.18 in FICA, computed as follows:
Earned income $4,000
Self-employment wage base (if this is more than $400, x .9235
you must pay FICA tax) $3,694
FICA tax rate x .153
FICA tax due with your tax return $565.18
Chances are, if you are unaware that this tax bill is coming, the money will be spent and you will have to scramble to get it by April 15.
WHAT SHOULD YOU DO?
ASK: When you start work ask the Human Resources Department whether you will be treated as an employee or an independent contractor. If you are treated as an independent contractor, save the money that will be needed to pay the self-employment taxes (and if applicable, income taxes) next April.
CONFIRM: When you receive your first paycheck, look carefully at the pay stub. Was any Social Security and Medicare tax withheld? If not, you need to put the money aside.
For more information, contact a tax advisor or check out www.irs.gov to find information about the self-employment tax.