5 ms·

Non american developer, working in full time job here. Can you explain a little how/why income tax is higher for freelancers?

NathanKP 16y ago
Normally the employer handles income tax. Employees receive a lower paycheck because taxes have already been taken out, but unless they made a bunch of money from other sources, their income tax should be very low or even non-existant, such that they get money back from the government. Freelancers on the other hand have to take taxes out of their income themselves, so what starts out looking like high pay is actually less than it looks. The danger in freelancing is forgetting about taxes and living right up to the extent of your means.
- mgkimsal 16y ago
  It's not just that. If that was it, it would just be a case of paying now vs paying later. I'm simplifying here, but there's something called FICA, which is about 15.2% of your pay. Typically employees have 7.6% withheld, and employers chip in the other 7.6%. It's effectively never paid or counted to the employee in the first place. Someone earning 100k at an employer would see $7600 paid in FICA. A self-employed person has to pay $15200 on the same $100k income (but half of that tax is deductible for other tax calculations - it gets convoluted!) So... self-employed people are paying 'more' , but the net effect of what the gov't get is the same. You just don't see some of that money as a typically w2 employee.
barrkel 16y ago
I'm not an American, but in most countries, employers pay tax for employees that employees don't see on their paychecks. In effect, it's income tax whose value is hidden for political purposes: employees only see the headline salary and the headline income tax, but in reality, the cost to the employer is usually more than the headline rate, even without the value of benefits etc.
- thierryd 16y ago
  On the other hand, in Canada you can put part of your mortgage paiement as deductible if you work from home (same thing with you computer, phone, etc). So that does lower your taxes compared with someone who work in a company. Is it the same in the US?
  - sethg 16y ago
    In the US, things that you buy and use for your job are tax-deductible (no doubt the IRS has a very detailed definition of “use for your job”). If your employer buys them for you, then the employer gets to deduct them as a business expense. Mortgage interest (up to a certain ceiling) is always deductible in the US, whether or not you are working from home. If a certain part of your home is set aside for business use, you can also deduct a proportional slice of your real estate taxes, depreciation, and various other things, but not, it appears, the principal.
  - ryanwaggoner 16y ago
    Yes. You can also deduct health insurance premiums, equipment, meals with clients, driving, travel for work, etc.
  - Tichy 16y ago
    In Germany we can deduct all sorts of business expenses. It sounds like a sweet deal, but employees get 1000€ as "default business costs" automatically. Since programming does not require that many resources, I find it is not necessarily so easy to get far above 1000€ in business expenses. If you buy something expensive like a computer, you have to split it across several years, so it doesn't help that much either.
- deleted 16y ago
  [deleted]
Cushman 16y ago
Other replies got it mostly right. There's a particular tax in the US to pay for Social Security and Medicare. If you're employed, your employer pays a half share of that in payroll tax. If you're self-employed, you have to pay the whole thing— about 15% off the top (up to ~$100,000) before paying standard income tax. That's called the Self-Employment tax. Self-Employment tax applies even if you wind up not owing any income tax. You get the benefit of being able to deduct business expenses, which employees can't do, but that usually doesn't make up the difference.
- trustfundbaby 16y ago
  > If you're employed, your employer pays a half share of that in payroll tax. If you're self-employed, you have to pay the whole thing Thanks for explaining that! I've been self employed for 6-7 years and I never could figure out the reason why this was (never really took the time to)
- sheats 16y ago
  One thing you can do to decrease your taxes is form an S-Corp. That allows you to pay yourself a moderate salary of 50K a year on which you pay all the income taxes. The rest you make you can take out as dividends and only pay dividend taxes on it.
  - ryanwaggoner 16y ago
    Get a good CPA before you try this; the IRS takes a very dim view of people doing this where the revenue is all based on a service that 1 person is offering.
johnarleyburns 16y ago
Because the government doesn't want us avoiding social taxes by going freelance. What really sucks is I've been working and living outside the US for years now but I still have to pay 15% of my income to the US government on top of all my local taxes due to self-employment tax.
gexla 16y ago
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.)
xenophanes 16y ago
Employers pay half of payroll taxes for their employees. Freelancers pay the full amount, around 15% for social security and medicare. Obviously that means employers offer lower salaries since they care about the total cost to them not the actual salary amount. So it's not really a bad deal for free lancers, just the amount you get paid has to be/sound higher to make things equivalent.

NathanKP 16y ago

Normally the employer handles income tax. Employees receive a lower paycheck because taxes have already been taken out, but unless they made a bunch of money from other sources, their income tax should be very low or even non-existant, such that they get money back from the government. Freelancers on the other hand have to take taxes out of their income themselves, so what starts out looking like high pay is actually less than it looks. The danger in freelancing is forgetting about taxes and living right up to the extent of your means.

mgkimsal 16y ago
It's not just that. If that was it, it would just be a case of paying now vs paying later. I'm simplifying here, but there's something called FICA, which is about 15.2% of your pay. Typically employees have 7.6% withheld, and employers chip in the other 7.6%. It's effectively never paid or counted to the employee in the first place. Someone earning 100k at an employer would see $7600 paid in FICA. A self-employed person has to pay $15200 on the same $100k income (but half of that tax is deductible for other tax calculations - it gets convoluted!) So... self-employed people are paying 'more' , but the net effect of what the gov't get is the same. You just don't see some of that money as a typically w2 employee.

barrkel 16y ago

I'm not an American, but in most countries, employers pay tax for employees that employees don't see on their paychecks. In effect, it's income tax whose value is hidden for political purposes: employees only see the headline salary and the headline income tax, but in reality, the cost to the employer is usually more than the headline rate, even without the value of benefits etc.

thierryd 16y ago
On the other hand, in Canada you can put part of your mortgage paiement as deductible if you work from home (same thing with you computer, phone, etc). So that does lower your taxes compared with someone who work in a company. Is it the same in the US?
- sethg 16y ago
  In the US, things that you buy and use for your job are tax-deductible (no doubt the IRS has a very detailed definition of “use for your job”). If your employer buys them for you, then the employer gets to deduct them as a business expense. Mortgage interest (up to a certain ceiling) is always deductible in the US, whether or not you are working from home. If a certain part of your home is set aside for business use, you can also deduct a proportional slice of your real estate taxes, depreciation, and various other things, but not, it appears, the principal.
- ryanwaggoner 16y ago
  Yes. You can also deduct health insurance premiums, equipment, meals with clients, driving, travel for work, etc.
- Tichy 16y ago
  In Germany we can deduct all sorts of business expenses. It sounds like a sweet deal, but employees get 1000€ as "default business costs" automatically. Since programming does not require that many resources, I find it is not necessarily so easy to get far above 1000€ in business expenses. If you buy something expensive like a computer, you have to split it across several years, so it doesn't help that much either.
deleted 16y ago
[deleted]

Cushman 16y ago

Other replies got it mostly right. There's a particular tax in the US to pay for Social Security and Medicare. If you're employed, your employer pays a half share of that in payroll tax. If you're self-employed, you have to pay the whole thing— about 15% off the top (up to ~$100,000) before paying standard income tax. That's called the Self-Employment tax. Self-Employment tax applies even if you wind up not owing any income tax. You get the benefit of being able to deduct business expenses, which employees can't do, but that usually doesn't make up the difference.

trustfundbaby 16y ago
> If you're employed, your employer pays a half share of that in payroll tax. If you're self-employed, you have to pay the whole thing Thanks for explaining that! I've been self employed for 6-7 years and I never could figure out the reason why this was (never really took the time to)
sheats 16y ago
One thing you can do to decrease your taxes is form an S-Corp. That allows you to pay yourself a moderate salary of 50K a year on which you pay all the income taxes. The rest you make you can take out as dividends and only pay dividend taxes on it.
- ryanwaggoner 16y ago
  Get a good CPA before you try this; the IRS takes a very dim view of people doing this where the revenue is all based on a service that 1 person is offering.

johnarleyburns 16y ago

Because the government doesn't want us avoiding social taxes by going freelance. What really sucks is I've been working and living outside the US for years now but I still have to pay 15% of my income to the US government on top of all my local taxes due to self-employment tax.

gexla 16y ago

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.)

xenophanes 16y ago

Employers pay half of payroll taxes for their employees. Freelancers pay the full amount, around 15% for social security and medicare. Obviously that means employers offer lower salaries since they care about the total cost to them not the actual salary amount. So it's not really a bad deal for free lancers, just the amount you get paid has to be/sound higher to make things equivalent.