Employee or Independent contractor

Q. I am a painter and my boss says I am an independent contractor. He says I have to pay all my own taxes and my paycheck will be my total wages instead of minus taxes. Is that correct?

A. Unfortunately, I can't make the distinction of whether or not you are actually an employee. I can tell you that in my experience many workers in the service industry like painters, plumbers and other laborers are incorrectly classified. The issue is the level of control exerted over your work. For a definitive answer, you can complete form SS-8 and send it to the IRS for review. I wrote an article about this topic that you can read here. For purposes of this blog, I will describe the effect of both scenarios from a tax perspective.

If you are truly an employee, then the employer matches what you contribute to Social Security and Medicare. Depending on your state, you could be eligible for health benefits. Your employer will also pay FUTA and SUTA (state and federal unemployment). Your state also requires that enmployers maintain some sort of workers compensation coverage in case you are injured on the job. As an employee, you get a certain level of protection again lay offs and on-the-job injury that the employer must pay for. You can see why certain companies try to skirt these requirements. They are expensive.

As an independent contractor, you are liable for self-employment taxes and have no work comp or unemployment insurance coverage in most cases. This means, the "employer" saves a ton of money. He also moves the risk off his own business and sticks it to the contractor. This also means that you the contractor must file quarterly estimated tax payments with the IRS or risk large penalty and interest payments. You are liable for all taxes.

In a mis-classified situation where you are actually an employee but considered a contractor by your "employer", it is very likely that the "employer" is not paying tax on his/her income either. The IRS has identified this as a significant source of the so-called "tax gap" and is looking closely at ways to find and audit organizations in these industries.

Good luck on your quest. Ignorance is often the cause of misclassification. However, more often than not, it is an outright attempt to hide from the government in my opinion.

Changing your withholding

Q. I had way too much withholding last year and got a huge refund when filing my tax return. How do I change that?

A. This blog is coming from the floor of the Exhibit Hall at the American Payroll Association 2008 Congress in Austin, TX. With almost 2000 payroll folks surrounding me, I get to see the other side of your question as well. Payroll folks sometimes can't understand why the regular employees don't know how to manage their withholding. I've done a lot of discussion in past blogs on the Form W-4. This will be yet another entry on the use of that form.

When you start working for a company, they are supposed to give you a Form W-4 to complete, along with a state version (if necessary) and an I-9 form to prove your right to work in the U.S. Most employees simply fill in the number of allowances that they have for children. For example, a married individual with 2 kids would say Married - 2. This could not be further from correct. An allowance for federal withholding purposes is worth $3,500 for 2008. This means that for each $3,500 of deductions that you can claim on your tax return, you should be claiming 1 allowance. If you itemize, you may be able to claim several more allowances than you have actual dependents. The back side of the Form W-4 has a section entitled "Deductions and Adjustments Worksheet" that can assist you in getting the number adjusted right.

The key when completing your Form W-4 is that more allowances produces less withholding and less allowances produce more withholding. If you get the right number of allowances at the beginning of the year, it will not be necessary to change the W-4 frequently throughout the year. As always, check with your CPA or tax adviser for assistance with your exact situation.

W-4 options

Q. What does the box mean on the W-4 Form that says "Married but withhold at higher single rate?"

A. This is one of the most frequent questions I get. The answer lies in an understanding of federal withholding. There are two withholding tables used by employers to withholding federal tax. One is for those who check the box "Single" in the W-4. The second table is related to those who check the box for "Married" on the W-4. There are also two income tax tables: Married and Single. The selection you make on the Form W-4 tells your employer which tax table to use.

Because "Single" withholding rates are often higher than those for Married individuals, there are times when Married people should choose "Single" for their filing status. This could be needed in cases of both spouses working, or one spouse has two or more jobs or the couple experienced some sort of taxable event for which there was no withholding.

At most companies, simply selecting the "Single" filing status is enough. However, some companies actually track the marital status of their employees and use the Form W-4 for this purpose. While there may be other legal issues at work here as to the need for tracking this information, for that type of employer, the employee should probably select Married but withhold at higher single rate" instead.

Keep in mind that the ultimate goal with this form is to match your tax payments through withholding with the tax liability you expect to have when you file your 1040 form at the end of the year. Consistent, even payments throughout the year is the easiest way to make this happen.

Direct Deposit and Stimulus Payment

Q. What happens if I no longer have the same checking account for my direct deposit to go into with the Economic Stimulus Check?

A. The IRS has a great section of Frequently Asked Questions regarding the Economic Stimulus payment. Many questions, like this one are already answered. According to the IRS website at this address, "Typically, the direct deposit will be rejected. After the IRS receives a rejection notice, the payment will be converted to a paper check and mailed to you." So, if you changed bank accounts since your refund was deposited into that account, you can expect to receive your stimulus payment on paper check at the last mailing address of record for you at the IRS.

For those that chose to have a paper check refund, or owed additional tax with their return, then a paper check will be issued. Keep in mind that the IRS announced an acceleration of payments of about a week based on the original schedule.

Anyone who has not filed a 2007 tax return or has not updated their mailing address recently will have their payment delayed. You will need to contact the IRS directly to resolve these types of problems/

Pennslvania and W4

Q. I need a Pennsylvania version of the W-4. Where are they?

A. Pennsylvania has no equivalent of the Form W-4. This creates huge problems with regards to the employee reporting to the employer what municipality they reside in. Often the town of reference in the address is not the same as the municipality for withholding purposes.

That is beside the point however. W-4 forms are used by payroll departments for setting the marital status and number of allowances for an employee. Because these items don't exist in Pennsylvania withholding there is no need for the form. PA is currently calculated as 3.07% of gross wages. You can't claim extra allowances to reduce withholding, you are just stuck at that percentage.

Therefore, when you provide new hire forms to your employer, all you need to provide is the federal W-4 and the I-9 plus any company specific documents requested. Now, if we could just figure out a way to get the state to simplify the number of local taxing jurisdictions, payroll in PA would not be so difficult.

How much tax for self-employed

Q. Is there a calculator that would help someone determine how much estimated payments I can make since I am self-employed?

A. Unfortunately, there is no easy-to-use tool for calculating self-employment liability for estimated payments. Because the self-employed have to match Social Security and Medicare, yet get a credit for it above the line on the 1040, the actually liability is much more complicated to determine.

The number you would start with is based on last year's tax liability. This is determined by your accountant when you complete your 1040 form and associated schedules. Essentially, you can split last year's liability into 4 parts and make that as your payment. If you anticipate an increase in revenue, you may want to increase that number to ensure that you do not end up with underpayment penalties. Again, your accountant can help you determine how much these payments should be.

Employees have several options for easy-to-use calculators to help them estimate their tax liability and payments. Online paycheck calculators can be found at the ADP Employer Resource Center, PaycheckCity.com, PayCycle.com and Payroll-Taxes.com. Due to the complex nature of the self-employed calculation, there is no similar tool for you however.

Form W4 and working spouse

Q. How do I complete the Form W-4 if my spouse is working or out of the country or retired?

A. Keep in mind that what I can discuss here is very general due to the nature of the question. The Form W-4 as mentioned before is the road map your payroll department uses to calculate your withholding correctly. A good rule of thumb is that if you claim an allowance on the W-4, your spouse cannot claim that same allowance. For instance, if you are married and put a "1" in box A, then your spouse cannot claim "1" in box C for you as well. If your total situation as defined by your accountant warrants claiming 6 allowances, then you and your spouse should probably split them in some fashion. If you both claim 6 allowances, chances are, you will be underwithheld and end up with a big tax bill the following April.

Page 2 of the W-4 gets into topics of two-wage earners which simply means both spouses are working or you as an individual have more than one job. Simply put, more than one job reduces the amount of allowances you can claim in total. By properly completing page 2 from the perspective of each job, you can get a good handle on how many allowances should be counted for each job. The General rule is the allowances should be claimed at the higher paying job. However, that is not always the case and is best defined by your tax adviser or accountant.