When you're self-employed, there is no withholding. You simply write a check out each year (or each quarter, if you make enough) for your taxes.
This has the effect of making you very aware of just how much money is going to you and how much money is going to the government. With withholding, people never see the money they're losing -- hard to miss what you've never had.
In general, though, increasing withholding is exactly what I do when I work as a contract employee. But I rarely do that any more. At some point, your rate just doesn't fit into a W-2 kind of pay scale.
I'm in an interesting spot because my income can be zero, nadda, nil, or it can be upper-middle class. It's all up to me and the market. Most of the tax laws, however, are written with joe sixpack the wage earner in mind. So I end up making a lot one year, owing a bunch of taxes, and then when the bill comes I'm making zero. Then I have to choose between paying taxes and feeding the family. Or the flip-side, you borrow money when you're making zero and then you start up a high-rate job and have to spend the first few months paying back loans instead of getting caught up on back taxes.
But like I said, listening to others I'm sure there must be something wrong with me. Maybe I should find a more "normal" job where I could have deductions taken out instead of being so independent entrepreneurial,and self-employed.
You're a new commenter to this thread, so I will try this again. Perhaps I've been poor at explaining it.
You're self employed. Let's say you sell services. It's the first week of the year.
The first week you did great. Let's say you made $5,000. Woo hoo! But wait, you say, part of that money isn't really yours. So what do you pay? Do you multiply 5K by 52 weeks in the year to assume an income? That's how most people's payroll taxes are done. So let's say you do that and immediately write a check for 1800 bucks for taxes.
Then you make nothing else the rest of the year. You've lost use of that money and you really needed it. Wrong answer.
Let's try again. Let's say you put it in the bank. Now you make another 5K. And another and another. After a month you've made 20K. 6K of that is in the bank.
Then there's no work for a month or two.
At the end of the quarter, you've got 6K in the bank for taxes. Do you write the check? Well -- what's your income going to be? You haven't made anything in two months. So you don't write the check. Then the next quarter you work every week. Wrong answer.
Or you write the check, and there's no more work for two months. Wrong answer.
Or you write the check and need a new server. Or you don't write the check and need the money. Or you get hit with another large business expense. Or somebody goes to the hospital. The randomness goes on and on, and without knowledge of just how your income is going to work for each week for the next year you're guessing at optimization strategies. Note that some of these unplanned expenses are tax-deductible events -- these are items you would take off from your income before taxes anyway. Some, of course, are not.
Allocating the money immediately doesn't work because there's no set amount to allocate without a predictable tax bill to prorate. Saving the money results in various scenarios where the savings conflict with other business realities and you've still got the prediction problem.
The most reasonable strategy that I can create is to pay some kind of guess and then catch up the following year -- after all, you always know what your taxes are for the previous year. But the fact remains that the tax system is made for people with predictable income where the employer takes the money out of their checks. And as the economy gets more diversified and more and more people run their own businesses, this assumption causes more and more problems.
I think calling all of that "poor planning" is a bit oversimplified.
If you make a large sporadic income, it's either from holding multiple payroll jobs, in which case you can file a form that adjusts your yearly income to the CRA such that your withholdings will make sense, or you're a contractor/business owner and you're paying your own taxes, possibly in installments anyways.
It's not like you're taxed at your peak monthly income. Withholdings are just estimates that can be adjusted.
It is very different having taxes automatically taken out of your paycheck and having to remember to pay them automatically on a quarterly basis.
Most people don't realize how big of a chunk gets taken out. And as was mentioned, as a self employed individual you also pay the "employer's" piece of Social Security which is an extra 7.5%.
If you're incorporated there may be taxes related to that. I pay a yearly fee for the privilege of doing business in Connecticut.
I also must file a yearly annual report with the state; which comes with a processing fee.
I also pay property taxes on business property, such as computers and desks and chairs. My accountant has me list all of these.
Many people go into sticker shock when I tell them to put aside 40% of their income to pay taxes.
it's not super hard as a self-employed person, if you don't want it to be. Just setup your business as a real company and pay yourself via payroll instead of pass-through
There may be other tradeoffs, but there may also be other advantages. the original point of just being aware of both sides of the coin is a big part of it, most people don't look at the deductions on their paycheck. hell, a significant number of people think their entire tax bill is just what they have to pay in April
Where I live, a salaried person will have tax automatically withheld and paid to authorities by their employer each week/fortnight. Someone self-employed usually has an estimate they pay quarterly or monthly, and then adjustments at the end of the financial year if the situation has varied from the estimate. I'm just saying I stockpile between tax bills (holding the cash against my mortgage to minimise interest) and my general style of living/spending means I can just redraw from the mortgage to make tax payments.
Yeah, I was under the impression you pay more taxes working for yourself, because you have to pay all the payroll taxes normally paid for by the employer. And then there is the corporate income tax you have to pay before you can pay yourself a salary. Maybe you can get more creative with deductions, but the base rate will be higher.
Not in my country, I actually get tax break for being self employed. In the end I pay less tax on my income than someone employed earning a similar income. Not to mention I make 2-3 times what I would make being employed. And I'm not playing any tax tricks.
There's not a single mention of taxes in the article.
I don't think that the average employee is aware that an entrepreneur/founder/self-employed person can save a lot of tax if they structure it right and are meticulous about it.
A self-employed person earning $70K a year can be better off than an employee earning $100K.
I never really considered this an issue. I've been self-employed since 2012 and kept a spreadsheet that calculated the quarterly payments I need to make, so I just sent that amount into a 1% APY savings account every time I got paid.
More recently, I took on a regular W2 job, and I've updated the spreadsheet so that it accounts for both W2 income (and any withholdings from that) as well as 1099 profit/losses (as I enter business expenses as well).
It was all pretty easy to set up and I just update it whenever tax brackets and standard deductions change (usually an annual thing).
From what I know, If you're self-employed you'll also have to pay payroll tax, which makes taxes end up close to 50% without even taking taking sales taxes into account.
However, self employed workers can write off work related expenses. This may help offset the higher taxes. On the other hand, as a freelance web developer, my overhead is so low I don't even bother with deductions (I'm living in the Philippines to take advantage of the freedom of self employment but costs are super low here.)
> It is tough, income is still less than I what I made in my cushy job
But you have more ways to avoid taxes (both legal and not so much). If you get paid cash for anything, you may be able to conceal the income. You can creatively shuffle losses into the limited liability corporation, to avoid being personally affected, and basically just sock it to whomever the corporation owes.
Self-employed people typically have way more ways to write off expenses.
In Canada, if you're an employee, you don't get to write off anything. Drive to work? Can't write off gas or car repairs as a business expense. Work from home a lot? Sorry, can't write off any portion of your rent or mortgage. All that changes if you're self-employed; you can write off every this and that: transportation; the proportion of your home that is your office. On the yearly tax return form, all employees can claim a meager little "employment amount": a token sum compensating them for their inability to write off anything.
I disagree and think this is completely wrong. I've paid a ton of self-employment tax and the write-offs for a web developer have never made me better off than someone who makes 100K and doesn't pay self employment tax. An employee making 100K and paying regular taxes and low state income tax probably has over 70K left over after taxes. How can someone making 70K pre-tax that has to pay self-employment tax do better than someone who gets > 70K after tax?
Taxes for self employed people are much more complicated than taxes for salaried employees. Everywhere that I know, taxes from salaries are automatically withheld by the employer - those taxes have probably been calculated by a tax accountant in the first place. There's practically no way you'd need to pay extra taxes if your only income is your salary, so you can opt out of filing taxes.
For self-employed people there are many more rules and regulations: How to write off which kind of cost and purchase, filing VAT if required, etc. so that's already cost efficient if you hire someone qualified.
And then what happens when you want to pay yourself a salary? Aren't you essentially paying corporate tax rate and income tax on that amount? Maybe that doesn't apply for a sole proprietorship, but does it for a small business?
This has the effect of making you very aware of just how much money is going to you and how much money is going to the government. With withholding, people never see the money they're losing -- hard to miss what you've never had.
In general, though, increasing withholding is exactly what I do when I work as a contract employee. But I rarely do that any more. At some point, your rate just doesn't fit into a W-2 kind of pay scale.
I'm in an interesting spot because my income can be zero, nadda, nil, or it can be upper-middle class. It's all up to me and the market. Most of the tax laws, however, are written with joe sixpack the wage earner in mind. So I end up making a lot one year, owing a bunch of taxes, and then when the bill comes I'm making zero. Then I have to choose between paying taxes and feeding the family. Or the flip-side, you borrow money when you're making zero and then you start up a high-rate job and have to spend the first few months paying back loans instead of getting caught up on back taxes.
But like I said, listening to others I'm sure there must be something wrong with me. Maybe I should find a more "normal" job where I could have deductions taken out instead of being so independent entrepreneurial,and self-employed.
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