Lesson 1.6 · Unit 1 · N-Q.1-3
When there is no employer to deduct anything
A driver, freelancer or small business owner is paid the whole amount with nothing taken out. That looks like a higher wage. It is not, because the expenses are the worker's, both halves of the payroll tax are the worker's, and the hours include the unpaid ones. Finding the true hourly rate is the core skill.
- Net earnings are revenue minus business expenses. Only the net is income for tax purposes.
- Standard mileage is an alternative to tracking car costs. A business mile is worth a fixed rate. This course uses \$0.65 a mile, a teaching figure. Use either mileage or actual car costs for the same car, never both.
- The self-employed pay both halves of FICA. Self-employment tax is 15.3 percent, applied to 92.35 percent of net earnings.
- Half of self-employment tax is deductible in figuring income tax, which is the tax law's way of recognizing that an employee never pays the employer's half.
- Nothing is withheld, so the worker sets money aside and makes estimated payments four times a year. A safe rule is to set aside a fixed share of each payment.
- Count all the hours. Waiting for the next job, driving to a pickup and buying supplies are unpaid hours that belong in the denominator of the hourly rate.
- Compare with an employee's equivalent wage. An employee earning \$18 an hour costs the employer \( 18 \times 1.0765 \) per hour. A freelancer needs to earn that much more per hour before expenses to match.
- Benefits are the worker's to buy. Health insurance, retirement saving and paid time off all come out of the earnings and belong in the comparison.
Where students lose marks: comparing gross receipts with a wage. A driver who takes in \$1,250 in a week has not earned \$1,250. After mileage, the phone and self-employment tax, and divided by all the hours, the true rate is much lower. Always subtract before dividing.
The problem. A delivery driver takes in \$1,250 in a week. She drove 520 business miles and pays \$15 a week for a phone plan used only for work. She works 34 hours of deliveries and spends 11 more hours waiting between orders. (a) Find the net earnings using the standard mileage rate. (b) Find the self-employment tax. (c) Find her hourly rate before and after that tax, counting all 45 hours. (d) Find the rate if she counted only the paid hours.
Step one: name the givens. Revenue is \$1,250. The mileage rate is \$0.65. The phone is \$15. All hours are 45, of which 34 are active.
Step two: the mileage deduction. \( 520 \times 0.65 = 338.00 \) dollars. Fuel is included in the mileage rate, so it is not subtracted again.
Step three: net earnings for (a). \( 1250 - 338 - 15 = 897 \) dollars.
Step four: self-employment tax for (b). The taxable amount is \( 0.9235 \times 897 = 828.38 \), and the tax is \( 0.153 \times 828.3795 = 126.74 \).
Step five: the rate before the tax, for (c). \( \dfrac{897}{45} = 19.93 \) dollars an hour.
Step six: the rate after the tax. \( \dfrac{897 - 126.74}{45} = 17.12 \) dollars an hour. Income tax has not been taken out yet.
Step seven: the misleading rate for (d). Dividing the gross \$1,250 by the 34 active hours gives \( \dfrac{1250}{34} = 36.76 \), about double the true figure. Both the expenses and the waiting time hide in that number.
Step eight: state the answers. Net earnings were \$897.00, self-employment tax \$126.74, and the true rate \$17.12 an hour after that tax. The advertised rate of about \$36.76 was a gross figure over active hours only. The comparison with an employee wage must use \$17.12.
Problems 1 to 5 are routine. Problems 6 to 10 are multi-step or ask for reasoning. Use \$0.65 a mile and the 15.3 percent on 92.35 percent rule.
- A freelancer invoices \$3,200 and has \$840 in business expenses. Find the net
earnings.
Show the full solution
\( 3200 - 840 = 2360 \). \$2,360.00
- Find the self-employment tax on net earnings of \$12,000.
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\( 0.9235 \times 12000 = 11082 \), and \( 0.153 \times 11082 = 1695.55 \). \$1,695.55
- A courier drives 1,200 business miles. Find the mileage deduction.
Show the full solution
\( 1200 \times 0.65 = 780.00 \). \$780.00
- A self-employed worker sets aside income for four equal quarterly payments totaling
\$4,800 for the year. Find each payment.
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\( \dfrac{4800}{4} = 1200 \). \$1,200.00
- A designer has \$28,000 of revenue and \$6,500 of expenses. Find the net earnings and
the self-employment tax.
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Net \( 28000 - 6500 = 21500 \). The tax base is \( 0.9235 \times 21500 = 19855.25 \), and the tax is \( 0.153 \times 19855.25 = 3037.85 \). \$21,500.00 net; \$3,037.85 tax
- Using the driver's figures in the example, find her hourly rate after
self-employment tax if she is able to cut the waiting time from 11 hours to 5, for 39
hours in all.
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Net after the tax is \( 897 - 126.74 = 770.26 \). Over 39 hours, \( \dfrac{770.26}{39} = 19.75 \). Cutting 6 hours of waiting raises the true rate by about \$2.63 an hour. \$19.75 an hour
- An employee earns \$18.00 an hour for 2,080 hours. Find the annual wages and the
employer's half of FICA.
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\( 18 \times 2080 = 37440 \). The employer's half is \( 0.0765 \times 37440 = 2864.16 \), so the job costs the employer \$40,304.16. \$37,440.00 wages; \$2,864.16 employer FICA
- A freelancer wants to match an employee's \$18.00 an hour for 45 hours, all of which she
counts. How much gross must she collect in a week, before expenses and taxes?
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The minimum is \( 18 \times 45 = 810 \). This is only the starting point: she also needs to cover the expenses, the self-employment tax and her own benefits, so the real target is higher. At least \$810.00
- A contractor has \$52,000 of revenue and \$9,000 of business expenses. Find the
self-employment tax and the half of it that is deductible.
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Net earnings are \( 52000 - 9000 = 43000 \). The taxable amount is \( 0.9235 \times 43000 = 39710.50 \), and the tax is \( 0.153 \times 39710.50 = 6075.71 \). The deductible half is \( 6075.7065 \div 2 = 3037.85 \). \$6,075.71 tax; \$3,037.85 deductible
- A student says, "I earned \$1,000 driving this week, so I earn \$25 an hour because I
worked 40 hours." List three things the \$25 leaves out.
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The \$1,000 is revenue, not earnings, so vehicle costs (or mileage), phone and any fees must come off first. The 15.3 percent self-employment tax on what remains also comes off. And any unpaid hours spent waiting or driving to pickups must be counted among the 40 or added to them. Each of these lowers the true hourly rate. Expenses, self-employment tax and unpaid hours