Tax implications of non-typical pay structures
About this video
Sal weighs the pros and cons of self-employment. Being your own boss brings flexibility, but it also brings risk, no regular paycheck or benefits, and full responsibility for taxes and paperwork, including a higher 15.3% rate for Social Security and Medicare. Business expenses can be deductible, which lowers taxable income.
You'll be able to
- list benefits and risks of being self-employed.
- explain why self-employed people pay a higher rate for Social Security and Medicare.
- explain how a business expense deduction lowers taxable income rather than taxes directly.
Key words
- Self-employment
- Working for yourself, for example running your own business or contracting, instead of being an employee.
- Withholding
- Tax an employer takes out of your paycheck and sends to the government for you.
- W2
- A tax statement an employer gives employees showing their pay and the taxes withheld.
- Payroll tax
- Tax tied to wages that funds programs like Social Security and Medicare.
- Tax deductible
- An expense you can subtract from your income before working out how much tax you owe.
- Taxable income
- The part of your income that tax is actually calculated on.
Transcript
- [Sal] So let's think about some of the pros and cons of self-employment. So I'm gonna make a column of pros and then in cons, maybe a nice scary red over here. All right, cons. Alright, so I think a lot of folks, when they imagine working for themselves, they imagine, well, hey, that sounds pretty good.
You can be your own boss. Your own boss, which means that you get a lot of flexibility. Flexibility, you kind of define the culture, how you're going to work, the hours, et cetera, you are to some degree the master of your own destiny. Now, being a master of your own destiny can be a double edged sword, because especially when you're starting off, this could be a little bit riskier, if you work for a big company, they have a lot of different clients across a bunch of different industries, maybe if things turn south a little bit in the economy, they're still going to keep people going because they're pretty diversified.
Well, if you're working for yourself, you might only have one or two customers initially, or you're contracting for folks and if one of them has issues, you might be in trouble. You are responsible for making the business work. So all on you, all on you, which I can tell you from personal experience, it can be pretty stressful when you're not sure where your next paycheck is going to come from or where the deals aren't showing up as quickly as you might expect.
There's also, above and beyond not getting a regular paycheck, no regular compensation, but that could also include things like benefits, you're gonna have to pay for your own health insurance, there's not gonna be any paid time off. The other thing is you have to figure out all of the taxes yourself.
When you work for a company, you're going to have withholdings, they're gonna give you W2 statements. When you file your taxes, you're gonna get other types of statements, and you're gonna fill everything out and maybe you'll get a refund or maybe you'll have to pay a little bit.
But when you are self-employed, it's all on you. So all taxes, paperwork, paperwork on you. So that might be a little bit more work for you to have to handle. Now, since we're thinking about taxes, a lot of folks don't appreciate that above and beyond regular income tax, you also have to pay for things like Medicare and Social Security.
Now, if you're working for a company, your company pays payroll tax, and above and beyond that, you pay 6.75% for things like Social Security and Medicare. While if you're self-employed, the current rate is actually 15.3% that you're going to have to pay of your income versus that 6.75%.
That's a pretty substantial difference. And once again, you are responsible for all of the taxes, the paperwork, et cetera. You have to be very organized here. Now, you might be saying, hey Sal, you're kind of bumming me out a little bit, there's a lot of work to be doing if you're self-employed, and it is true, there is a lot of work, but I will now give you another benefit, it goes back to being flexible.
Anything that if you are self-employed, anything that, well, I would say not anything, but a large category of things that you are using in order to do that self-employed work can oftentimes be tax deductible. So more business expenses. Business expenses, deductible, deductible, which once again, it doesn't mean, if say you have a $5,000 business expense, it doesn't mean it's $5,000 off your actual taxes.
It means you're $5,000 off of your taxable income. So you will pay less taxes on it, depending on your tax rate, it decreases taxable income. So I'll leave you there, these are all things to think about, and obviously these can change over time. Some people might say, well, it's risky to work for a company, they might lay you off, sometimes it might not have anything to do with the economy.
While if you're your own boss and you can start building up a clientele and customers, maybe it's safer in the long run or vice versa. So all things for you to be thinking about.
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