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What are the tax implications of being a freelancer, an employee or an investor?

tax implications

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Credit Sesame discusses the tax implications of income from different sources such as freelancing, employment or investment.

There are many ways to make money, including full-time employment, part-time employment, freelancing, side gigs and investing. If you get income from multiple sources or you’re thinking about adding an income stream, you may like to think about the tax implications.

Adding income means more tax to pay, probably, and each type of income may have its own tax implications.

Employees

Working for someone as an employee usually means earning an hourly wage or a set salary. Payment can also be in tips or bonuses.

Employees often have some taxes withheld by their employer. If you earn more than $600 annually, these are listed on the W-2 form you get each year from your employer. This form lists income and Social Security and Medicare taxes withheld, among other things.

Social Security is taxed at 6.2% each for the employer and employee, for a 12.4% total. The Medicare tax rate totals 2.9%, with the employer and employee each paying 1.45%.

Paying taxes on tips

Workers receiving $20 or more in tips in a single month must report those tips as income and pay Social Security and Medicare taxes on them. The tips must be reported to the employer and on an individual income tax return. Employees must also keep a daily tip record.

Tips include not just cash and charged tips, but also noncash tips such as tickets and passes, or any items of value.

Common deductions for employees

Itemizing deductions makes sense if you have deductions that add up to more than the standard deduction for your tax situation. Here are some common deductions that employees, and anyone else, may want to consider:

  • Child tax credit of up to $2,000 per child.
  • Earned income tax credit of up to $6,935 for low- to moderate-income workers.
  • Child and dependent care credit of $3,000 per dependent.
  • Adoption credit of up to $14,890.
  • American opportunity tax credit of up to $2,500 for education.
  • Student loan interest deduction of up to $2,500.
  • Charitable donations.
  • Mortgage interest tax deduction.
  • Saver’s credit of up to $4,000 if filing jointly for retirement account contributions.
  • 401(k) contributions deductions from paychecks of up to $20,500.
  • Electric vehicle tax credit of up to $7,000.
  • Health Savings Account contributions deduction.
  • Medical expenses deduction.

Self-employed

If you work for yourself, or sometimes even for a company, the Internal Revenue Service considers you self-employed. This includes running a part-time business or working as a gig worker. Terms such as freelancer, contractor and independent contractor are used for self-employed people. You may consider yourself to work for a ride-share company such as Uber, but you are a contractor and not an employee.

Generally, self-employed people are required to file an annual tax return and pay estimated taxes quarterly. They pay a self-employment tax to pay Social Security and Medicare taxes that employees usually pay through their employers. 

Self-employed individuals must also pay their income tax themselves, as opposed to employers pulling most income taxes out of employee paychecks.

Common deductions for self-employed workers

If you use part of your home for business, you may be able to use home office deduction to lower your taxes.

Other tax deductions may be eligible as self-employed include:

  • Mileage and vehicle expenses
  • Office supplies
  • Insurance premiums
  • Credit card and loan interest
  • Retirement savings
  • Business travel
  • Business meals
  • Continuing education
  • Startup costs
  • Advertising
  • Self-employment taxes

Investors

If you make a living as an investor and get income from investments, then you must file a tax return. Even if you are an employee or self-employed, you must still report investment income on your tax return.

Investment income may be subject to a 3.8% tax if your modified adjusted gross income is more than $200,000 (single filers) or $250,000 (married filing jointly).

Investment income may be from selling stocks and making a profit, but it can also come from interest and dividends. Some dividends are taxed at your ordinary income tax rate, while others are taxed at lower long-term capital gains tax rates.

Short-term capital gains are for capital assets held for a year or less, and are usually taxed at your ordinary income tax rate. Long-term capital gains are for assets held for more than a year, and the tax rates are typically lower than your ordinary income tax rate and generally max out at 20%. Collectibles such as rare stamps and art can have a long-term capital gains tax rate of 28%.

Investment income can also come from rental and royalty income, and non-qualified annuities. Selling your home isn’t usually considered investment income.

Typically, you must pay taxes on the sale of investments only when you profit. Subtract what you paid for your investment from the sale price to see if you had a gain or loss. A gain likely means paying taxes on it, while a loss may be able to offset other realized gains or you can take a deduction.

Deductions for investors

Losses on investment sales are one type of deduction. A common deduction that employees, self-employed workers, investors and others can use is through tax-advantaged retirement accounts. A tax deduction is allowed today for money you invest in a retirement account such as a traditional IRA or 401(k). Taxes are paid when you withdraw the money in retirement.

Contributions to other retirement accounts like the Roth IRA or Roth 401(k) are taxed now but withdrawals in retirement are tax-free.

Investors may also be able to claim tax deductions for investment interest expenses. This is interest paid on money borrowed to buy taxable investments, such as interest on loans to buy investment property or interest on margin loans to buy stock in a brokerage account.

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Disclaimer: The article and information provided here is for informational purposes only and is not intended as a substitute for professional advice.

Aaron Crowe
Aaron Crowe is a freelance journalist who specializes in personal finance topics. He has written for Wise Bread, AOL, AARP, Bankrate and other websites that focus on financial literacy and saving money. He has also worked as a newspaper reporter and editor. You can follow him on Twitter @AaronCrowe.

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