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My husband is about to begin working as an independent contractor, after having been working for others for years. I am trying to figure out how much to save for taxes. I know the self-employment tax is equal to twice the amount he was paying as an employee. But what about Medicare tax? As an independent contractor will he be required to pay that, too? Is it reasonable to run his hourly rate and hours through www.paycheckcity.com and save the amount they show for taxes (with the Social Security amount doubled)?

And all these taxes are only on his net business income, right? (He's going to be fronting travel expenses, then getting reimbursed -- I'd hate to think he has to pay Social Security and Medicare on the expense reimbursements!)

Thanks for your help!
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But what about Medicare tax? As an independent contractor will he be required to pay that, too?

Yes. The self-employment tax is a combination of social security and medicare. The rate is 15.3% of his net income from self-employment. If he gets over the maximum wages for social security (about $85-90k) the self-employment tax also drops to just the Medicare rate, which is 2.9%.

Is it reasonable to run his hourly rate and hours through www.paycheckcity.com and save the amount they show for taxes (with the Social Security amount doubled)?

I suppose that would be a rather inexact way of doing it. Just make sure to double the medicare tax as well.

And all these taxes are only on his net business income, right? (He's going to be fronting travel expenses, then getting reimbursed -- I'd hate to think he has to pay Social Security and Medicare on the expense reimbursements!)

Right. He can deduct any other expenses he incurs as well - perhaps some auto, telephone, office supplies, etc.

--Peter
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Pete-
He also gets to take advantage of the new self-employed 401(k), doesn't he? I don't know all the details, but it sounded like a great deal, much better than an IRA.
suze
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He also gets to take advantage of the new self-employed 401(k), doesn't he? I don't know all the details, but it sounded like a great deal, much better than an IRA.

I'm not sure what you're talking about. There have been 401(k)'s, among other choices, for the self-employed for a long time. Details are in IRS Publication 560.

Phil
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The self-employment tax is a combination of social security and medicare. The rate is 15.3% of his net income from self-employment. If he gets over the maximum wages for social security (about $85-90k) the self-employment tax also drops to just the Medicare rate, which is 2.9%.

The effective rate is a little lower because he gets to reduce his net income from SE by multiplying it by .9235 before applying the 15.3%. And then there's another little break because he gets to subtract half of his SE tax from his AGI.

--fleg
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He also gets to take advantage of the new self-employed 401(k), doesn't he? I don't know all the details, but it sounded like a great deal, much better than an IRA.

There's all sorts of pension/retirement plan options available to the self-employed. Solo 401k's are just one choice.

But none of them will affect self-employment (Social security and medicare) taxes. They only help reduce income taxes.

--Peter
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The effective rate is a little lower because ...

Yes. But try explaining all that to a client. So they understand it. There are accountants (probably lots of them) out there that don't really grasp this.

And for planning purposes, it's really not important. For preparation, they're vitally important. But then again, the forms walk you through the details if you like doing things by hand, or software will do the detail calculations for you with no problem.

Besides, bypassing that bit of complexity will result in the person putting slightly more money aside for taxes, which - as long as it's not grossly overdone - is usually a good thing.

--Peter
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And all these taxes are only on his net business income, right? (He's going to be fronting travel expenses, then getting reimbursed -- I'd hate to think he has to pay Social Security and Medicare on the expense reimbursements!)
---

Actually, there is a caveat here I only recently caught onto. He must report the reimbursement as income, but gets to deduct his actual expenses. If they are equal, it is a wash (but still accounted for). Many companies charge a 10% markup on reimbursements for administrative costs and presumably for opportunity cost of fronting the money. If your husband can negotiate this, that extra 10% would be taxable income, but you'd still be ahead. It could also prompt the other company to pay for tickets and hotels up front.

knight427
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Thanks for all the replies! I'd love to do a 10% markup on expenses, but that's not in the contract -- I think their theory is that the hourly rate is high enough to compensate for administrative expenses (it's almost 50% higher than what he gets for similar work when he's working as an employee for other companies). Fortunately we have secured 0% financing for the expenses so we're in good shape there.
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I'm glad to hear of others venturing into the self employed world. I would never go back to working as an employee.

Recognize ALL of the contract details are negotiable. If you have an agreement already, you need to honor it. For future engagements, a 10% markup is pretty common. You might ask what the company he will be contracting with charges. Ask them what their "procurement burden" is. Even the very large goverment contractor will get paid a few percent 'markup'.

As far as the 50% higher than employee work - that is probably a down right seal for the company. By the time all of the employer's expenses are covered (Social Security, unemployement taxes, holiday pay, sick pay, and other overhead cost), they probably considered they were paying him 50% more than his 'employee wage'.
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Just happened to run across your question and decided to add a little more to it... Remember as a self-employed contractor you're able to deduct your very first dollar of expense compared to being an employee and only those expenses in excess of 2% of your AGI...

As far as self-employment tax, my accountant believes it's probably one of the most unfair parts of the tax law... As an employee, you paid 7.65% for Social Security and the company matched it at 7.65%. Being self-employed you are now responsible for both sides or 15.3% as someone else mentioned. Don't let all this get to you. There are also many advantages for being self-employed that you would not be able to enjoy as an employee... rj
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Wow! I was amazed to see this thread on Hot Topics!

Yes, we realize now that he should have been more aggressive in negotiating his rate. They have a standard contract for the kind of work he does and won't pay markups on expenses, but he definitely could/should have negotiated a higher hourly rate. Live and learn... next time he'll know.

Again, thanks to all for the great info!
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Wow! I was amazed to see this thread on Hot Topics!
________________________________
That isn't as special as it seems. Actually this thread has relatively few recs. for a "hot topic". But it is good to remind people that tax planning should be a good activity for December (if you haven't done it before.)

But they do pick things from the different topic areas, on a revolving basis, to show off what a diverse list of interests there are at TMF. One time we had something from the Opera board, just to show it was there, I think.

Bill


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That isn't as special as it seems. Actually this thread has relatively few recs. for a "hot topic".

Oh. Sorry.

If you need me, I'll just be over here... put in my place...
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Wow! I was amazed to see this thread on Hot Topics!

You should still feel special - someone may well have have nominated you post of the thread and that's how it got to HTs.
(There's often a link over there ---> for nominating)

rad
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It's not that I think it was such a great post, or that I'm/it's so special. I just think it's pretty amazing that somebody would actually take the time out of their day to make absolutely, positively sure I know it's NOT special.

Sheesh.

Happy holidays.

mlk58
who still really appreciates all the other great responses
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My husband is about to begin working as an independent contractor...

As a small businessman myself I REALLY REALLY think you should make an appointment with a CPA or EA for tax advice and planning. There are things that you probably have no idea you can deduct as legitimate business expenses. Likewise there may be things you plan to do that are no-no's. If you shortchange yourself you lose. If you shortchange the tax authorities you lose ... then you lose again in penalties ... and again in the valuable time it takes to attend to their wishes. You'll also learn when and how to make the tax payments. (e.g. In California sales tax payments may be made annually or quarterly depending on taxable sales; state income tax deposits are due monthly but only if the personal income tax deposit amount exceeds $500 or if it's the end of the quarter, at which time you deposit whatever amount you've withheld. I believe Lewis Carroll wrote our tax code.) The cost of the accountant's service, being directly related to your business, is almost certainly deductible.

KennyO
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Thanks for the advice, Kenny. DH has been doing this business on a small scale for several years so we do have a good idea already about legitimate business expense deductions. He provides a service so fortunately we dont' have to worry about sales tax or inventory or anyting like that. But I will suggest that we think about an appointment with a CPA. (We gave up our last one several years ago because we didn't feel like we were getting our money's worth, but it's never a bad idea to re-evaluate things like that!)
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