From Salaried Employee to Independent Contractor

David Congreave

Here is a question from one of our readers. Feedback is very welcome:

Ian Congreave

As you are describing the termination of your husband's employment, the final payment of commission from employment should be paid on the regular payday for the final pay period. However, if your state has rules that require final payments to be paid immediately on termination, those rules would take precedence. See http://www.dol.gov/compliance/topics/wages-other-last-paycheck.htm

Similarly, as the employment is ending, the employer should withhold taxes from the commission earned during the final period of employment.

I am more concerned about the idea of the employer wanting your husband to become an independent contractor, presumably (although you do not say this) doing exactly the same job as he did when he was an employee - the only difference being the manner of payment and taxation.

Your husband (and his employer) should consider the IRS guidance at http://www.irs.gov/businesses/small/article/0,,id=115041,00.html and at http://www.irs.gov/businesses/small/article/0,,id=99921,00.html

Employment status is not something that can be determined simply by agreement between your employer and your husband - it is a decision based on the facts.
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Ian Congreave, PayPerShop owner

PayPerShop provides a free weekly UK, US and Worldwide payroll news service - http://www.paypershop.com/latestnews.html

dmishesq

I second Ian's concern about the transition from salaried employee to independent contractor. Most people who end up as "independent contractors" fail to realize the significance of this transition. They are just happy because they seemingly have more money in their check each week or month. This is because they fail to realize the significant tax increase that they will be subject due to the change in employment status. Previously, as an employee, the employer matched the employee's FICA and Medicare contributions. The employee was thus only paying 7.65% of their gross payroll toward FICA and Medicare. Once the taxpayer becomes self-employed this matching ceases to exist and the independent contractor becomes liable for "self-employment tax" which is 15.3%. If you are thinking to yourself, "wow that's exactly double" it's because you're right. It is double. The self-employment tax is set at the rate that it is to equal the employer/employee relationship. There are a variety of ways to equal this imbalance out by the use of corporations but that's beyond the scope of this reply.

Parting words of advice. As an independent contractor you are now subject to self-employment tax and thus you have a responsibility to make estimated tax payments using form 1040-ES. Instead of listening to your accountant and trying to make those payments quarterly (every 90 days), I always strongly suggest to my clients that they make estimated payments of roughly 20-30% of their gross weekly or monthly pay, WHEN THEY GET THEIR PAYCHECK. Using this system, it is very difficult to fall behind as you are approximating what was happening when you were a salaried employee. Making estimated tax payments is the single best way of staying out of IRS problems moving forward. Otherwise you are in the midst of creating financial chaos of your life. Best of luck to you.

Darrin T. Mish
Attorney at Law
http://www.getirshelp.com