Independent Contractors Must Pay Self-Employment Taxes

If you moonlight (have a second job) as an independent contractor, you'll have to pay self-employment taxes on the income you receive. Carnell Specks found out about this rule the hard way.

Specks, a Houston police officer, moonlighted by providing security services to various private businesses in the Houston area. He earned about $44,000 doing this work one year. He listed this "other income" on his tax return for the year and paid no self-employment tax (Social Security and Medicare taxes) on it.

What Happens If Your Employer Incorrectly Treats you as an Independent Contractor

Unfortunately for Specks, the companies he worked for treated him as an independent contractor and reported all the money they paid him to the IRS on Form 1099-MISC (now, Form 1099-NEC), the form used to report payments to independent contractors.

Because these firms regarded Specks as an independent contractor, they did not withhold or pay any Social Security or Medicare taxes for Specks. The IRS computers whirred away and quickly discovered that Specks had self-employment income (reported on the Forms 1099-MISC), but had paid no self-employment taxes on his tax return. The result: He got audited.

Was Specks an Employee?

Specks tried to claim to the IRS that he was really an employee of the firms he moonlighted for, thus he owed no self-employment tax. This argument just wouldn't fly.

The tax court noted that Specks had been issued Forms 1099-MISC by the firms for his services. So, he knew they considered him an independent contractor. If he thought he should have been classified as an employee, he should have told these hiring firms about it.

Specks didn't qualify as an independent contractor anyway because it was clear he was running an independent security on the side. Specks had to pay the self-employment taxes he should have paid plus interest and penalties. (Specks v. Comm'r, T.C. Memo 2012-343.)

Rule for When You Must Pay Self-Employment Taxes

Here's a simple rule: If you work as an independent contractor, it's up to you to pay income and self-employment taxes (Social Security and Medicare taxes) on the payments you receive. The firms that hire you need not, and will not, do so.

You'll know if you're being treated as an independent contractor instead of an employee if you're not asked to complete an IRS Form W-4, Employee's Withholding Allowance Certificate when you're hired.

Taxes You Have to Pay on Your Self-Employment Income

You have to pay income taxes and Medicare taxes on all your self-employment income. You must also pay a 12.4% Social Security tax and 2.9% Medicare tax on such income. However, the Social Security tax is subject to an annual income ceiling. Your self-employment income above the ceiling amount isn't subject to Social Security tax. There is no income ceiling for the Medicare tax. An additional 0.9% Medicare tax took effect on January 1, 2013 to fund Obamacare. Once a taxpayer's income exceeds the applicable threshold, the effective Medicare tax rate is 3.8% (the standard 2.9% rate plus an extra 0.9%). The additional tax is only paid on that portion of net self-employment income that exceeds the threshold.

If you have Social Security taxes withheld from your wages by your employer, you must pay the Social Security tax on your wages first. If your wages are at least equal to the Social Security annual tax ceiling, you won't have to pay the 12.4% Social Security tax on your self-employment income. But no matter how much you earn from your job, you'll have to pay the 2.9% Medicare tax on all your self-employment income.

However, if your employee wages are lower than the Social Security tax ceiling, you'll have to pay Social Security taxes on your self-employment income until your wages and self-employment income combined exceed the ceiling amount.

You pay income tax, Social Security tax, and Medicare tax on your self-employment income four times per year in the form of estimated taxes that you send in to the IRS. If you underpay, you'll have to pay tax on the amount plus interest when you file your return for the year.

Getting Tax Help

If you need tax help, talk to a tax professional, such as a certified public accountant or a tax attorney. A tax professional can prepare tax returns or provide tax information, guidance, or representation before the IRS.