“The Financial Realities of Independent Contracting: What You Need to Know”

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Understanding the Financial Implications of Independent Contracting

For over 72 million people working as independent contractors, either full-time or part-time, understanding the financial implications is crucial. According to MBO Partners, independent contracting grew by 89% between 2020 and 2023. But does it pay the same as a regular job? The short answer is: not exactly. While contracting offers flexibility and autonomy, it also comes with its own set of financial challenges. Here are six key factors to consider before diving into independent contracting.

Your Taxes May Be More Complex (and Expensive)

As an independent contractor, you are considered self-employed by the IRS, which means you will likely pay more in taxes compared to an employee earning the same hourly rate. You must pay self-employment taxes of 15.3%, covering Social Security and Medicare contributions. While deductible expenses like health insurance, office costs, and retirement contributions can offset these taxes, you will need to meticulously track and document your income and expenses. Additionally, if you owe more than $1,000 in taxes for the year, you must make quarterly estimated tax payments to avoid penalties.

You Cover Your Own Expenses

While qualified business expenses are tax-deductible, you are responsible for covering a range of costs, including setting up and maintaining a home office and paying for health insurance. Some expenses may overlap with personal costs, such as your home and internet service, but others, like work equipment and additional utilities, are extra. Your overhead will vary depending on the type and volume of work you do, so it’s essential to factor these costs into your contracting rate.

Pay Can Be Unpredictable

The flexibility of independent contracting can also lead to unpredictable income. Work may not always be steady, and clients can be slow to pay. Additionally, the concept of paid time off does not exist for contractors. Budgeting with irregular income is a crucial skill, and having an emergency fund and a cushion in your checking account can help manage cash flow fluctuations. Good credit can also be beneficial, as loans and credit can smooth out income irregularities.

Applying for Loans and Credit Is More Complicated

While being a contractor doesn’t directly affect your credit score, self-employment income requires more documentation when applying for loans or credit. You may need to provide tax returns, bank statements, and a current-year profit and loss statement. If you are new to contracting, you might not have a substantial track record to present to lenders or creditors.

Health Insurance Is on You

If you don’t have a job with benefits, you will need to use your contracting income to pay for health insurance. According to the 2023 Employer Health Benefits Survey by the Kaiser Family Foundation, the average annual premium for employer-sponsored health insurance is $8,435 for single coverage and $23,435 for family coverage. You may find lower-cost options through a government-run health insurance marketplace.

You Fund Your Own Retirement

As a contractor, you don’t have automatic retirement contributions or a 401(k) with employer matching. You must set up and contribute to your own retirement plan. Options include traditional IRAs, Roth IRAs, and SEP IRAs. Even if you contribute to a retirement plan at another job, consider opening an IRA to maximize your retirement savings.

The Bottom Line

Earning money as a contractor is different from being an employee. Understanding the factors that affect your contracting income can help you evaluate opportunities, set prices, and manage your financial position more effectively. As a contractor, you need to take a more active role in managing your money, from tracking income and expenses to paying for your own insurance and making timely retirement contributions.

For any mortgage service needs, call O1ne Mortgage at 213-732-3074. We are here to help you navigate your financial journey with expert advice and personalized service.

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