Thursday, February 15, 2018

The Pajama Tax

It's tax time. And thanks to the identity thieves and Equifax, we are all trying to get our taxes done a little early this year before someone else claims a big return in our name. I am not sure of the likelihood that it would actually happen, but the media has me thinking enough about it that I decided to start my taxes early too.

Being self-employed has changed my life in so many ways. Most of them have been positive changes. I can't really say the same about my taxes. Last year, I earned so little income from my writing business that it wasn't that big of a deal to do my taxes. But this year, I started to earn more money and I learned a few things that I didn't really understand last year.

The biggest lesson was something called the self-employment tax. When I started planning for my taxes, I took the money I earned writing for the year and multiplied it by the tax rate for that income bracket to come up with an estimate of what I might owe this year. But when I started to actually input the numbers into TurboTax it was coming out much higher. Almost twice as much as I had expected to pay. Even with my deductions. 

At first I thought I had entered the numbers wrong, so I did it again. But it came out the same. As I was looking through the details, I saw a line item called the self-employment tax. It turns out that when you are self-employed you not only have to pay income taxes, but you also have to pay your own Medicare and Social Security taxes, which account for an additional 15% of your income. 

So in fact, I did have to pay twice as much as I expected. We all have to pay Social Security and Medicare taxes. But if you work for a company, they deduct it directly from your paycheck and they actually pay a portion of those taxes for you. Employers are required to cover 50% of those taxes and the employee covers the rest. Now that I am self-employed I need to cover the entire amount.

None of my clients take out any taxes when they pay me, so it is up to me to figure everything out on my own. Which brings me to the next lesson I learned. When I did my taxes this year, TurboTax said that I owe a penalty of $196 for under-estimating the taxes that I owed to the IRS throughout the year. I thought I could just wait and pay all of my taxes at the end of the year, but the IRS expects that if you are self-employed you will pay estimated taxes to them throughout the year.

Since I did not pay any estimated taxes in 2017, I have to pay everything at the end of the year. That is 30% of my income, as opposed to the 15% that I was expecting, plus this year's penalty for not paying taxes throughout the year like I was supposed to. On the same day I was working on my taxes, the health care bills from my surgery were posted online. Needless to say, that also cost a lot more than I was expecting to pay.

As I sat in front of the computer staring at this less than positive financial news, I felt defeated. I started to wonder how I could ever make a living as a self-employed person and whether I had made a mistake leaving the safety and comfort of a salaried job that included full health care benefits. I started to worry that at some point my savings would run out and I wouldn't have a nest egg to cover unexpected costs like my surgery or these taxes.

It wasn't a great moment for me. All along I have felt so empowered running my own business and getting clients and sending out invoices and watching the money come in. It is not a lot of money compared to what I used to make, but I have been doing it on my own terms. 

In that moment, I wondered if I could really make this work. And I thought about whether I should start looking at other options. One of my clients had offered to hire me full-time, but I told them I was happy working as a freelancer. Maybe I should call them up and say yes.

Then I added up the actual hours I worked last year and I realized that I am working about 20 hours a week as compared to 60 or 70 hours a week in my old job. And I am doing it all in my pajamas. And going to yoga on Tuesday mornings. And going to Target in the middle of the afternoon if I need to. I am not accountable to anyone, except myself. And I am happy. For the first time in my life, I can honestly say that I love what I do. And I am proud of what I do.

So I made a decision not to give up and to keep moving forward. If I am only working 20 hours a week then I have room to take on more clients this year. And maybe I can get an increase in my rates from some of the clients who are really happy with my work. 

The last two years, I focused a lot of my energy on becoming a minimalist and consolidating my expenses so that I could afford to work for myself. Now it is time to focus on increasing my income so I can keep doing the work that I love.

Being self-employed doesn't mean that I don't have a boss. It means that I am the boss. I am my own employer. And I have to treat myself like an employee. I am going to set up quarterly estimated tax payments for this year that include Medicare and Social Security taxes. And I am going to set up new monthly income goals that take into account all of the taxes I have to pay and still leave me enough money to live my life.

The self-employment tax makes me feel like I am being penalized for working for myself, when it is actually a gift. It is the best thing that has ever happened to me. And it is worth fighting for. So, I have renamed the self-employment tax. It is now called the pajama tax. It is the extra tax that I pay so I can work at home in my pajamas.

And when you really think about it, how many people out there who work for a big company would gladly give up 15% of their salary if they could do their job at home in their pajamas every day? I bet a lot of people would take that deal in a heartbeat, if their only boss would let them. I think I am pretty lucky. I have a great boss. 

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