I recently received this email from someone considering a new position:
“I haven’t worked a job that wasn’t under the table in nearly a decade, so forgive my ignorance on this matter. Basically, I’m thinking about accepting a part-time job that will be a W-2 situation. The hourly rate is $20, but I’m concerned that after taxes, it would only be about $16 per hour. I have an 18-year-old daughter, who will be starting college in the Spring. My question is: Will I still get the Earned Income Credit (EIC) on my tax return? I will only be making approx $15,000 per year or less with this job. Even without EIC, would I get a tax refund because my income will still be so low? I’m just not sure how taxes work. I imagine they’re all taken out as I go with a W-2, and then if I prepare a tax return, I get some or all of the money back? Last year my employer gave me a 1099 & I still got a refund.”
Income and payroll taxes can certainly be confusing, especially if the person is used to being paid “under the table”… I’ll do my best to explain it, though my ability to give personal tax advice is limited by how little I know of the taxpayer’s individual situation, and because there are liability issues if they’re not a client of mine. However, I felt my blog audience might benefit from the exercise.
First: there are two types of ways of being paid that are referred to as “under the table” — and given the small amount of information in the excerpt I received, I’m taking a guess that it’s the second kind.
1) Real “under the table” pay means that none of the money the worker receives is documented to the required federal and state agencies, and neither the employer nor the employee is reporting it and paying taxes.
2) An independent contractor situation is where an employer gives a 1099 to the employee, meaning that the employer did not pay taxes for the employee, and the employee gets stuck with all the taxes.
Neither of these is desirable for the employee/taxpayer. If it’s #1, then that means the neither the employee nor the employer paid into Social Security, Medicare, Unemployment or Workers’ Compensation… which means that when it’s time to claim from any of those programs, they’re out of luck. If it’s #2, then it means the employer isn’t paying their share of Social Security or Medicare — the employee has to pay all of it in the form of self-employment tax. And again, there’s no Unemployment tax or Workers’ Compensation insurance being paid, which is nice for the employer… but awful for the employee if they lose their job or get hurt.
Secondly, the Earned Income Credit has nothing to do with whether a taxpayer is paid as a W-2 employee or 1099 independent contractor. As long as a person is single with one child (which sounds like the situation here), they can make up to $40,320 and still qualify for the credit — the maximum credit is $3,461 in this case, for 2018.
The problem with truly getting paid under the table with the EIC is that some people lie and report less than they actually made, in order to make it look like they qualify under the limit. But remember, that’s #2 above. If the taxpayer is getting a 1099 or a W-2, there’s no difference with the credit either way.
Lastly, I know it seems like a $20/hr job only ends up paying $16/hr, but that’s not accurate. All the taxes that are being withheld are potentially eligible to be refunded at the end of the year when the employee/taxpayer prepares their tax return — if their tax liability ends up being less than they paid in, then they get the balance returned to them — the EIC generally increases that amount, but they may get a refund even if they don’t qualify for the EIC… in which case they may want to adjust their tax withholding for the following year to have less taken out with each paycheck. A tax preparer can help fill out the W-4 form to get this as close as possible when an employee takes on a new job.
The amazing part is that their employer is paying half of the Social Security and Medicare taxes for the employee! This doesn’t happen with a 1099, which is why usually an employer is taking advantage of their employees when they try to do that instead of using a W-2 form. When the taxpayer goes to claim Social Security and Medicare, the reason the system can afford it is all of the employers that pay part of these taxes on behalf of their employees, along with paying the Unemployment tax to the state and springing for Workers’ Compensation insurance. Being an employee is WAY better than being a 1099 contractor. And they’re both better than being truly paid “under the table”, since when those folks go to claim Social Security or Medicare, there’s nothing there for them… because they never paid into the system. It can come as a horribly unfortunate shock.
Here are a few good articles that back up what I just explained:
I hope this is a helpful lesson on being an employee. It’s really a great way to go, because the employer is taking care of their staff… instead of taking advantage of them.
A colleague recently shared this wonderful link that compares each type of QuickBooks Online subscription and which reports are available in each one:
A quick note about something all Illinois businesses and tax preparers should be aware of — 