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Accounting and Tax Planning

Employee or Contractor?

By Danielle Fitzpatrick

Taxpayers often ask about the difference between being an independent contractor and an employee. Although it may seem like they both perform similar work, there are some significant differences when it comes to their responsibilities and when filing annual income-tax returns.

Perhaps you are currently working for an employer and are considering becoming a contractor, or maybe you have just graduated college with a degree and are trying to decide which option is best for you. Whichever route you decide to take, it is important to know the differences so that you can plan accordingly.

Differences in Responsibilities

You are considered an employee when the business you work for has the right to direct and control the work you perform. You are given specific instructions on when and where to work, and are often provided training and the necessary equipment needed to perform specific duties. As an employee, you receive regular wages and may be eligible for benefits such as insurance, retirement, vacation, and sick pay.

You are considered a contractor when services are provided for a specific period of time. Rather than being paid a regular wage, you are paid a flat fee for contractual services. As an independent contractor, you are not eligible for benefits or training through the businesses you are performing services for. You are in charge of your own schedule and typically have several clients for which you are providing services.

Differences at Tax Time

One of the biggest differences between being an employee and a contractor is how your income is taxed on your income-tax return. Unfortunately, the difference is often not realized until an individual files their return and is faced with a significant tax burden.

As an employee, your employer pays 50% of your Medicare and Social Security (FICA) taxes. The other 50% is withdrawn from your regular paycheck along with federal and state (if applicable) tax withholdings. If any expenses are incurred and unreimbursed by your employer, the expenses are not deductible for the employee. On an annual basis, you receive a Form W-2, which shows your taxable income along with all taxes that you had withheld throughout the year.

“One of the advantages of being a contractor is that you can deduct expenses you incur in relation to the income you receive. Record keeping is extremely important when becoming self-employed in order to ensure that you are tracking all applicable income and expenses.”

As a contractor, you are considered self-employed (a sole proprietor). You are now responsible for 100% of the FICA taxes, also known as self-employment taxes. No federal or state tax withholdings are withdrawn from the income you receive, and you may be required to make quarterly estimated tax payments. On an annual basis, you receive a Form 1099-MISC showing the gross income you received in excess of $600 for each business you performed services for. All of the income you receive as a contractor is reportable on Schedule C, which is filed with your individual income-tax return, or on a business tax return if you choose to become incorporated.

One of the advantages of being a contractor is that you can deduct expenses you incur in relation to the income you receive. Record keeping is extremely important when becoming self-employed in order to ensure that you are tracking all applicable income and expenses. Expenses that may help offset your income include, but are not limited to, vehicle expenses, travel expenses, supplies, fees paid for continuing education, and the renewal of professional licenses.

Some Examples

Say you are an employee making $25 an hour and working 40 hours a week. For this example, note that nothing is being withheld for benefits. Your paycheck would look like the following:

Weekly Pay ($25 x 40 hrs.) $1,000
Less:
Federal Taxes Withheld       $200
State Taxes Withheld             $50
FICA Taxes Withheld             $77
Total Weekly Pay              $673

Now, say you are a contractor and charge $25 an hour to provide services to three businesses totaling 40 hours for the week. You receive a total of $1,000 for the week. In addition, you purchased $30 in office supplies and drove 250 miles for the week. Your net income for the week would be:

Gross Income             $1,000
Less:
Office Supplies                $30
Mileage Expense           $145
Taxable Net Income    $825

Now you’re thinking, why am I not a contractor? I bring home over $300 more a week! Yes, you bring home more for the week, but you cannot forget that taxes are not being withheld from your income. You will be responsible for paying these taxes on a quarterly basis and/or when you file your tax return.

As an employee, you report $1,000 as taxable wages on your income-tax return, from which federal and state taxes have already been withheld and will hopefully cover your tax liability. As a contractor, you have taxable net income of $825, but you are now responsible for self-employment tax, in addition to regular income tax that you have not yet paid.

Conclusion

So, should you become an independent contractor or an employee? There is no right or wrong answer; each individual needs to make their own decision and determine what will work best for them and their situation. However, whichever route you decide to take, be sure to consult your tax professional for advice to eliminate any potential surprises and ensure that you are prepared when it comes to filing your annual income-tax returns.

Danielle Fitzpatrick, CPA, is a tax manager at Melanson Heath. She is part of the Commercial Services department and is based out of the Greenfield office. Her areas of expertise include individual income taxes and planning, as well as nonprofit taxes. She also works with many businesses, helping with corporate and partnership taxes and planning.

Workforce Development

The Truth About Employee Disengagement

By Brad Wolff

Most companies struggle with employee disengagement. It’s costly in productivity, profitability, and stress. Gallup’s engagement survey data published in 2017 found that two thirds of U.S. workers are not engaged.

American companies have invested billions of dollars per year for many years to solve this problem. The results? The needle still hasn’t moved. How much has your experience been similar? Could this data simply reveal a general misunderstanding of the true causes of disengagement?

The Acme Corporation was suffering a 41% turnover rate. A recent survey showed that 85% of their workforce was disengaged. The general attitude of apathy, complaining, and cynicism permeated the culture. This was puzzling to management since they attempted multiple efforts to improve engagement.

These were well-planned and executed programs such as team-building exercises, social events, and pay raises. All showed early enthusiasm and positive survey results that generated optimism. Unfortunately, the magic always wore off within a few weeks. In despair, Acme engaged a firm with a very different philosophy than their other advisors. This firm focused on helping executive leadership understand the root causes and solutions. Within nine months, disengagement improved from 71% to 26% and turnover dropped to 19%.

The door to solving this dilemma opened when Acme management acknowledged that since their previous solution attempts were ineffective, their current way of seeing the problem must be flawed. This wisdom, humility, and openness paved the way to learn the true root causes of their disengagement. Once root causes are clearly understood, the solutions usually become obvious.

Fixing engagement issues: What works?

The first step is for the company leaders to take an honest, objective view of the company culture (beliefs and behaviors that determine how people interact and do their work) that impacts and drives the way people think and behave.

That’s why lasting change occurs when focusing at the culture level rather than specific individuals. Below are the relevant human psychological needs that are the actual root causes of people’s engagement level. Examples of mindsets/philosophies that effectively address these needs follows each need. Engagement will improve when management’s actions align with people’s psychological needs.

• To feel valued and understood. Management earnestly listens to employees’ concerns, opinions, and ideas with the intent to understand and consider their merits before responding. This replaces the common responses of defending positions or punishing employees for expressing contrary viewpoints. Management isn’t required to agree with the employees. What’s important is the sincere effort to listen, understand and consider their inputs.

• To express our gifts and talents. Management puts a focus on aligning roles and responsibilities with the gifts and talents of the individuals. We all bring a substantially higher energy and engagement (and productivity) when we do work that we like and are good at. As legendary management consultant Peter Drucker said, “A manager’s task is to make the strengths of people effective and their weaknesses irrelevant.”

• Meaning/purpose in what we do. This means that employees have a clear understanding of how their work impacts the mission and vision of the organization. Don’t expect them to figure this out on their own. People are much more motivated when they realize that their efforts truly matter.

• Internal drive for progress or development. Employees are at their best when there is “healthy tension” (not too low, not too high) to meet clear and reasonable standards. This means fair and consistent accountability and consequences based on performance relative to agreed-upon standards. Being too nice and lax harms engagement since people inherently desire growth and realize that standards and consequence help them do this. People are motivated when they focus on: “What did I achieve today?” What did I learn today?” How did I grow?”

What doesn’t work:

In short, anything that doesn’t authentically address the root causes of disengagement is doomed to fail. If the message is ‘look at this nice thing we just did for you’ rather than ‘this is how we value you as human being,’ it’s highly likely to fail.

Examples of the ‘nice thing we just did for you’ include most team-building events, social mixers, company newsletters, upgraded office environments, etc. Even pay and benefit increases have an initial rush soon followed by the familiar “right back where we were” rebound effect. That’s not to say companies should not do these things. They’re nice add-ons after the day to day essentials of human psychology are authentically addressed.

In summary, it’s understandable that we gravitate toward easy, quick-fix solutions to our problems. There are plenty of people to make these suggestions and sell them to us. They also don’t require us to identify our own personal contributions to the problems which we’d prefer to avoid. However, as in most things in life, there is no substitute for working at the cause-level and creating new habits of thinking and behavior.

If you’re serious about creating the high engagement level lead to more profits with greater ease and personal satisfaction, this is what it takes. As a bonus, openly addressing personal challenges that make you human will increase your effectiveness and fulfillment in every area of your life.

Brad Wolff specializes in workforce and personal optimization. He’s a speaker and author of, People Problems? How to Create People Solutions for a Competitive Advantage. As the managing partner for Atlanta-based PeopleMax, he specializes in helping companies maximize the potential and results of their people to make more money with less stress; www.PeopleMaximizers.com.