Like it or not, the gig economy is here to stay, especially for younger workers and job searchers. While, according to a study from Intuit, 34 percent of workers under 30 are working temporary and/or independent contractor jobs at any given time, and statistics from the BLS show about another 10 percent are permanently freelancers or self employed, nearly 80% of millennials have participated in the gig economy at least once, whether as Uber drivers, contract bloggers and writers, social media marketers, participants in brand-new unstable startups, or at more traditional employment agencies. That’s not to say all of them want to stay there… only 1 out of 11 don’t want to eventually work a standard full time job.
While the instant payment may be appealing (especially for last minute rent payments!) and the freedom of scheduling allows for working whenever and wherever we want, there’s a surprise in store for many new gig economy workers at tax time! Unlike traditional employers, who require employees to complete and sign a W-4 form at the start of employment, no federal or state taxes are withheld. How does this affect you? To put it bluntly, it’s not good, especially if you didn’t prepare through the year for what could be a massive tax hit.
Federal tax: Most of the time, you will have to pay as much federal income tax as if you were working for a formal employer. The one exception is if you are self-employed through an LLC or a partnership, in which case it may be possible for you to make use of the pass-through deduction and reduce your taxable income by 20 percent.
State tax: Just like federal tax, this will be the same as if you worked for a formal employer. The difference here is instead of it coming out of every paycheck as a withholding, now it’s February and you’re liable for the whole year’s tax bill.
Social Security: This is an additional 12.4% tax, which is actually twice what it would be if you were working for as a full time employee. Since you are self-employed, you will need to pay both the employer and employee contributions, which are 6.2% each of pre-tax income, on the first $128,700 of earnings.
Medicare: Just like the Social Security contribution, the Medicare tax is doubled for self-employed workers, because you are paying both the employer and employee contributions. However, there is no upper limit.
There is one silver lining though. While there are plenty of additional taxes, there are even more deductions available. For one thing, the “employer” contribution to the Social Security and Medicare taxes is itself deductible. Also, if your business involves expenses (gas) or depreciation (such as wear and tear on a car from those thousands of miles of Lyft driving), you may be able to deduct those too, if the total is enough to equal or exceed your standard deduction. If you are a partner in an LLC or professional partnership, the pass-through deduction is another option, which could save you up to 20% on taxes.
To maximize your deduction, and minimize the chances of an audit, the best thing you can possibly do at tax time is consult a financial professional for more complete, personalized advice for your situation. It might cost you now, but the peace of mind (and savings on penalties and attorney fees when you would have been audited!) are well worth it!