Key ideas

1. Employees split payroll tax with the employer. A W-2 employee pays 7.65% for Social Security and Medicare. The employer pays a matching 7.65%.
2. Contractors pay both halves themselves. Self-employment tax is 15.3% on 92.35% of net profit, plus regular income tax. Nobody withholds it for you.
3. The job decides, not the form. The IRS looks at control over the work, the money and the relationship. Calling you a contractor doesn't make you one.

Vocabulary

Independent contractor

A worker who is in business for themselves and paid without tax withheld, often reported on a Form 1099-NEC. They pay their own self-employment tax.

Self-employment tax

Social Security and Medicare tax for people who work for themselves. It is 15.3% on 92.35% of net profit, on top of income tax.

401(k)

A retirement savings plan offered through an employer. Money comes straight from your paycheck, often with an employer match.

Adjusted gross income

Your total income for the year minus a short list of adjustments, like deductible IRA contributions and student loan interest. Many tax rules and programs use it.

Unemployment insurance

A state program that pays part of your old wages for a limited time after you lose a job through no fault of your own.

Employer match

Money your employer adds to your retirement plan when you contribute, up to a set percentage of your pay.

Work it out

Dev, a graphic designer, has two offers: $60,000 as an employee or $60,000 as a contractor with no expenses. He compares Social Security and Medicare tax only.

1. Pay
2. Taxable for self-employment (92.35%)
3. 1099 self-employment tax (15.3%)
4. W-2 employee share (7.65%)
5. Extra tax on the 1099 offer

Check yourself

1. Which worker has Social Security and Medicare tax withheld from each paycheck?

   • A. A freelance writer paid per article
   • B. An employee who gets a Form W-2
   • C. A driver paid through a gig app

2. A contractor has $20,000 of net profit. About how much self-employment tax is due?

   • A. $1,530
   • B. $2,826
   • C. $3,060
   • D. $4,000

3. What decides if you are an employee or a contractor?

   • A. The title in your offer letter
   • B. Being paid by the hour
   • C. Whether you work from home
   • D. How much control the company has over the work and the relationship

Your turn

If you have any 1099 income, open a separate savings account for taxes and set an automatic transfer of 25% of each payment. Then run your expected profit through the self-employment tax calculator below.