Self-employed individuals, unlike employees, don’t have someone withholding Social Security or Medicare (FICA) taxes along with pre-payments toward their federal (and state, where applicable) income tax from their wages during the year.
They are not being paid a wage; instead, a self-employed individual must keep a set of books showing income and expenses associated with their self-employed business that will allow them to determine their taxable profits (or losses). While an employer and an employee each pay half of the FICA taxes due on an employee’s wages, a self-employed person pays 100% of these taxes, termed the self-employment tax or SE tax for short, on his or her self-employment profit. If the individual has more than one self-employment activity, the net profits and losses from all of the self-employment activities are combined to determine the amount of the SE tax. However, two spouses have self-employment income, the couple cannot combine their SE incomes when figuring their individual SE tax.
Taxpayers often will hire an individual or firm to provide services at the taxpayer’s home. Because the IRS requires employers to withhold taxes for employees and issue them W-2s at the end of the year, the big question is whether or not that individual is a household employee.
Determining whether a household worker is considered an employee depends a great deal on circumstances and the amount of control the hiring person has over the job and the worker they hire. Ordinarily, when someone has the last word about telling a worker what needs to be done and how the job should be done, then that worker is an employee. Having a right to discharge the worker and supplying tools and the place to perform a job are primary factors that show control.
The Internal Revenue Service (IRS) computes standard mileage rates for business, medical and moving each year, based on a number of factors, to determine the standard mileage rates for the following year.
As it does annually around the end of the year, the IRS has announced the 2019 optional standard mileage rates. Thus, beginning on Jan. 1, 2019, the standard mileage rates for the use of a car (or a van, pickup or panel truck) are:
58 cents per mile for business miles driven (including a 26-cent-per-mile allocation for depreciation). This is up from 54.5 cents in 2018;
20 cents per mile driven for medical or moving* purposes. This is up from 18 cents in 2018; and
14 cents per mile driven in service of charitable organizations.
* For years 2018 through 2025, the deduction for moving is only allowed for members of the armed forces on active duty who move pursuant to a military order.
Generally, all monetary awards as the result of a legal action are fully taxable, with one exception. Under the exception, the tax code allows an exclusion from gross income for damages received due to a personal physical injury or physical sickness. Consequently, when a lawsuit is based on a physical injury or sickness, all damages (other than punitive damages, which are generally always taxable) flowing from that suit are treated as payments received due to a physical injury or sickness and are therefore excludable from income. This is true whether or not the recipient of the damages is the injured party.
The Tax Cuts and Jobs Act that was passed last year included a new tax credit for employers that allows them to claim a credit based on wages paid to qualifying employees while they are on family and medical leave.
To qualify for the credit, an employer must have a written policy that provides at least two weeks of paid family and medical leave annually to all qualifying employees who work full time, which can be prorated for part-time. The wages paid during the leave period cannot be less than 50 percent of what the employee is normally paid.
The credit is variable. It begins at 12.5% and increases by 0.25%, up to a maximum of 25%, for each percentage point that the rate of payment exceeds 50% of the employee’s normal pay.
Not all provisions of the Tax Cuts and Jobs Act are beneficial to taxpayers. One notable negative provision is the suspension of the deduction for employee business expenses. Under prior law, taxpayers who were employees were able to deduct expenses related to their employment as a miscellaneous itemized deduction, to the extent the expenses exceeded 2% of their adjusted gross income. Yet, under the tax reform, employee business expenses will not be allowed for tax years 2018 through 2025.
However, this new limitation does not apply to individuals who are self-employed. For this group of taxpayers, expenses such as business use of their personal vehicle, business-related travel, work-related education, and use of a qualified home office for business continue to be tax-deductible on their business schedules. Furthermore, tax reform actually provides them with more liberal expensing options and, for some, even a special deduction of 20% of qualified business income.
One of the first trouble spots of the new tax reform is the W-2 withholding for 2018. Passage of the new law in late December hasn’t given the IRS much time to develop new withholding tables. This can be a big issue, as the recent Tax Cuts & Jobs Act (TCJA) substantially altered the tax rates and standard deductions, did away with exemption deductions, and increased the child tax credits—all elements of how the withholding allowances and tables have been structured in the past.
One major difference between being an employee and being self-employed is how you deduct the expenses you incur related to your work. A self-employed individual is able to deduct expenses on his or her business schedule, while an employee is generally limited to deducting them as itemized deductions.
That means self-employed individuals benefit by deducting their expenses directly on their business schedule, which can then result in a reportable business loss if the expenses exceed their business income.