Taxes

Q&A: When an employee is misclassified as contractor

January 13, 2025 By Liz Weston

Dear Liz: A parent recently wrote to you about a son who was being paid as a contractor. I know someone else who got a job that did not “take out taxes from his paycheck.” Such workers believe they are pocketing more money, but unfortunately, too many do not know about the nature of withholding. They only learn if they choose to file for their expected refund, but instead discover an exorbitant tax liability that a paycheck-to-paycheck worker cannot pay.

The sad fact is that many of these employers improperly classify their workers, who are truly employees, as independent contractors! And they do this to avoid paying their own portion of Social Security and unemployment taxes and also workers compensation insurance.

If workers believe that they have been misclassified (the IRS website provides all criteria), they can file IRS Form SS-8 and Form 8919, which will allow them to pay only their allocated half of their Social Security taxes. Hopefully the IRS will then contact these employers to correct their wrong classifications. And finally, it should be a law that, when hired, all true independent contractors should be given a clear form (not fine print on their employment agreements) that informs them of their status and the need to make estimated tax payments.

Answer: A big factor in determining whether a worker is an employee or contractor is control. Who controls what the worker does and how the worker does the job? The more control that’s in the employer’s hands, the more likely the worker is an employee.

However, the IRS notes that there are no hard and fast rules and that “factors which are relevant in one situation may not be relevant in another.”

The form you mentioned, IRS Form SS-8, also can be filed by any employer unsure if a worker is properly classified.

Q&A: Health savings accounts offer a rare triple tax break. Here’s what to know

January 7, 2025 By Liz Weston

Dear Liz: Can I contribute additional money to my health savings account, above the amount I’m contributing through payroll deduction? Also, I have an HSA account from a previous employer and one from my current employer. Can I combine the two?

Answer: If you have a qualifying high-deductible health insurance plan, you can contribute up to $4,300 this year to an HSA if the plan covers just you or $8,550 if the plan covers your family. If you’re 55 or older, you can contribute an additional $1,000. You can make additional contributions if your payroll deductions for the year, plus any employer contributions, fall short of the limit.

Maximizing your contributions can make sense because HSAs offer a rare triple federal tax break. Contributions are pre-tax, the money grows tax deferred and qualifying medical expenses can be paid with tax-free withdrawals. You can invest the money in your HSA for growth, and the balance can be rolled over year after year, making it a powerful potential supplement to other retirement plans. Although HSAs can be used any time to pay for medical costs, many HSA owners pay those expenses out of pocket so their accounts can continue to grow.

Consolidating an old HSA into your current one can be a smart move because combining accounts can reduce account fees and make it easier to manage your investments. You’ll also run less risk of losing track of an account.

The best way to consolidate would be to contact your current HSA provider and ask them to facilitate a direct trustee-to-trustee transfer from the old account. However, not all providers allow “in kind” transfers of investments. It should be no problem to transfer any cash in the account, but you may be required to sell the investments. You won’t owe federal tax on such a sale, but some states, including California, will tax any capital gains that result.

Q&A: A first paycheck means getting to know Uncle Sam

December 30, 2024 By Liz Weston

Dear Liz: My recently graduated child got a job and he will be given a 1099 tax form for his earnings. I know he will have to file his taxes differently and will need to pay both state and federal income taxes, but will he also make payments toward Social Security? Will these months (and maybe years) go toward his lifetime “credits” of paying into Social Security?

Answer: The company is paying your son as an independent contractor rather than as an employee. That means he will need to file his taxes as someone who is self-employed. So yes, he’ll be paying into Social Security — and he’ll be doing so at twice the rate of employees who receive W2s.

Normally, Social Security and Medicare taxes are split between employees and employers. Both pay 7.65% of the employee’s wages, for a total of 15.3%. Self-employed workers must pay both halves.

Your son won’t have taxes withheld from his earnings, so he’ll likely need to make quarterly estimated tax payments to avoid penalties. A tax pro can help him set up these payments and suggest legitimate expenses he can use to reduce his tax bill.

Q&A: Clearing up some confusion over those proprietary funds

December 30, 2024 By Liz Weston

Dear Liz: Your recent column about proprietary funds confused me. You mentioned that selling these funds can trigger capital gains tax. Is it not true we can move investments directly from one money manager to another and not take a capital gain as long as the funds remain invested?

Answer: If you can move a fund from one investment company to another, then it likely is not a proprietary fund. For example, Schwab, Fidelity, Vanguard and many other firms create funds that bear their names, but these investments can be bought and sold at other brokerages.

Proprietary funds, by contrast, typically lock customers into investments that can’t be transferred to another firm. To get your money out, you have to sell the fund, which can trigger a tax bill. This is a significant downside and one investors should understand before committing their money to this type of fund.

Q&A: After a windfall, questions on what to do with the cash

December 30, 2024 By Liz Weston

Dear Liz: After selling my house and downsizing at age 84, I am cash rich for the first time in my life. My goal now is not so much to grow the money substantially, but to avoid paying taxes on my investments, as I would have to do with certificates of deposit. Are tax-free municipal bonds my best option, or what would you suggest?

Answer: If you’re in a high tax bracket — roughly 32% or higher — the lower interest rates paid on municipal bonds can still give you a good-enough return to make buying them worthwhile. If you’re in a low tax bracket, the math doesn’t work so well.

Also, municipal bonds aren’t covered by FDIC insurance the way a certificate of deposit would be. Investing in bonds involves some risk. The chances of default are minimal if you choose highly-rated bonds, but your bonds could lose value if interest rates rise.

Consider using some of your cash to consult a fiduciary, fee-only planner who can help you figure out a strategy that reflects all aspects of your financial situation, not just your tax bill.

Q&A: Tax Deductibility of Home Equity Loans and Lines of Credit

December 23, 2024 By Liz Weston

Dear Liz: You recently wrote about home equity lines of credit and home equity loans. You might have mentioned that these are tax deductible under certain circumstances.

Answer: Yes, but the circumstances are increasingly rare.

Technically, the interest on a home equity loan or line of credit can be deductible when the money is used to improve your home. However, you must be able to itemize your deductions to take advantage of this write-off. Thanks to increases in the standard deduction, fewer than 10% of taxpayers itemize.