My Nephew's Taxing Experience

One of the reasons why opposition to tax increases is growing is the fact that more and more people are either self-employed or are small business owners.

Unlike the rest of us who never see the money that our state and federal governments simply take from our pay before our paychecks are even written, these people are paid in full by their clients and they then have to turn around and write checks to pay their taxes.

While the end result is the same, psychologically they are world's apart.

In the first instance you are giving up something that you never had physical possession of and also did not have to go through the motions of giving it up – out of sight, out of mind.

Further, since the government has designed the system to over, rather than under, withhold, most people not only don't pay taxes in the sense of physically transferring cash to the government, they get money back at the end of each year.

Rather than dreading tax day, these people look forward to it as a day they receive a windfall from the government. In contrast, self-employed people actually receive the money and then have to give a chunk of it to the government – they feel the pain of paying taxes.

I know because I have been both a wage earner and a self-employed tax payer. While I am currently an employee with money taken from my pay for taxes and will receive a refund this year, I did get to observe, in my children and nephew, both the joys of a refund and the pain of paying taxes.

Since all four of my children had jobs for at least part of the year, I sat down with each of them individually and guided them through doing their own taxes on Intuit's Turbo Tax.

While I tried to explain how to manage their money in order to reduce their tax liability in the future and pointed out that the Social Security and Medicare amounts (which, for them, exceeded the amounts withheld for state and federal income taxes) withheld were not coming back to them, their focus was on the refund number in the upper left corner of the screen.

The refund was real and tangible – a windfall or bonus, so to speak. The fact that they had worked to earn this money and were then forced to make an interest free loan to the government which was just now being returned to them, did not register.

Then I received a call from my nephew in Wisconsin.

He was in his dorm room trying to do his taxes using a free on line tax service but the program kept showing $141 due even though his total income from summer and after school jobs was a little over $4,000 with a little under $200 withheld for income taxes.

When his father couldn't figure out what was wrong, he tried me. I, too, was dumbfounded as my youngest had earned about $3,000 and got a full refund. After questioning him for about ten minutes, I finally went to my computer, fired up my Turbo Tax, and had him read off his data so I could enter it.

I assumed that there was a flaw in the system he was using and that I would find it with the Turbo Tax. He had two W-2 forms and a Form 1099-Misc . The 1099-Misc accounted for about half his income and the two W-2s the other half. We got all the way through and my system showed $141 due.

Looking at the summary sheet on my screen I saw his total income minus his standard deduction, which was greater, and a Taxable Income Figure of zero.

However, below that figure was a line labeled Other Taxes with $317 due. It only took a second for me to realize that this was the so called Payroll Tax which small business owners and self-employed people dread and with good reason.

The Form 1099-Misc represented income from self-employment and no taxes, including Social Security and Medicare, are withheld from self-employment income.

What had happened was that the owner of a couple of small apartment buildings in the small city that he lives in called on him periodically during the summer to help out with odd maintenance jobs. Since it wasn't steady work, he wasn't hired but just called when needed and, if he was free would work and get paid.

While no income tax was due, Social Security and Medicare taxes were due as they apply from the first dollar of income (Social Security taxes apply only to the first $97,500 of wage income while Medicare is applied to a person's entire wages for the year).

The Social Security and Medicare rate is steep as the employee is taxed at the rate of 7.65% while the employer is required to pay an additional 7.65% of each employees' pay.

However, since self-employed people are both employee AND employer they get slammed with both for a total of 15.3%. Instead of being the recipient of a refund check, my nephew suddenly became a real TAX PAYER .

I suspect that my nephew will now pay closer attention when politicians talk about taxing and spending because he will now realize that it is his money they are talking about.

As our economy continues to change and more people become self-employed the screams for tax relief will increase.

After all, look at the response King George III received when he attempted to force our ancestors to dig deeper into their pockets to pay his three cent tax every time they purchased a pound of tea.