One of the biggest objections I see to employee status is that being an employee would eliminate the mileage deduction. Now that AB5 has passed and that couriers for Grubhub, Postmates, Doordash, Uber Eats may well become employees, this is an important question. The answer?
It would. They took away the deduction for unreimbursed expenses.
But then again, in most cases it really wouldn't matter.
the most important thing when thinking about taxes… is NOT the taxes you pay. It's how much you have left over after taxes.
Here's why: The most important thing when thinking about taxes whether as an employee or an independent contractor is NOT the taxes you pay. It's how much you have left over after taxes. When you look at the big picture and run the numbers, the bottom line is almost universally going to favor the employee over the independent contractor.
Employee Status Would Eliminate the Mileage Deduction in Nearly All Cases.
Here's why some people are concerned. When we are independent contractors, we pay taxes on our profits, not on our earnings. That means that being able to claim the expenses related to driving will greatly reduce our taxable income, and that reduces our taxes. Less taxes means more money left over.
When you are an employee, you lose the ability to write off the business expenses, simply because you are no longer operating a business.
You can see why that creates a lot of concern. That means your taxable income is a lot higher, and that means your taxes are higher.
But does that mean you're worse off? You have to look at the total picture to answer that.
The difference in how employee earnings and taxes work and how they work for contractors.
There are a lot of similarities and some differences in how taxes work. Now, because this is a question brought on by the passage of AB5 in California, we're going to use California examples. But let's look first at the basics of how you would be paid and taxed both as an employee and as a contractor:
Differences in how you get your money.
As a contractor, everything you receive is considered income. Even when a company gives you money because of parking or tolls, or they calculate your fee based on miles, it is still considered income.
As an employee, you get your wages and tips, and possibly bonuses, and all of those are considered income. In California, minimum wage is $12 per hour even for tipped employees, which means your tips are paid on top of the minimum wage. California law requires companies to reimburse you for expenses and that likely will come out as a mileage reimbursement. They can figure out whatever formula for that that they want, but if you can demonstrate your actual expenses are higher, they have to pay the difference. That reimbursement is NOT taxable income (unless it exceeds the higher of 58 cents a mile or your actual expenses)
Differences in the basis of your tax
As a contractor, you are taxed on your profit. That means that the tax is based on what is left over after you subtract your expenses from your income. This is why you can claim your miles as a contractor. As an employee, you are taxed on your income. You cannot deduct your miles, but you are also reimbursed for your miles.
Differences in taxes themselves.
The major difference between contractors and employees is in FICA/Medicare tax (as an employee) and Self Employment tax (as a contractor). These are basically the same thing, just different terms and different rates. For both, you pay the tax on every dollar you earn (or on profit if you are self employed) – your itemized or standard deductions do not reduce this amount. The huge difference between the two is that a contractor pays 15.3% tax, while an employee only pays 7.65%. That is because the employer pays the other half.
Differences in deductions
A contractor does have two tax deductions available to them that an employee doesn't have. Because a business owner is allowed to claim the FICA and Medicare taxes they pay for their employees as an expense, to make it fair they now let contractors take a 7.65% tax deduction. That deduction comes off both their overall profit (for self employment tax) AND their taxable income. A contractor can also usually qualify for a business owner tax deduction of 20% of their profit.
How Does This Balance Out?
Let's run the numbers. Frank is a full time courier in San Francisco. He averages $1,000 per week, $520 of that is tips and the rest delivery fees and promotions from the delivery company. He drives on average 600 miles a week. He works 50 weeks of the year. How would this look for the year? (Note, we are not going to assume any paid time off for Frank as an employee). Frank is single and takes a standard deduction, he does not have any other income or deductions. California State Tax is calculated using this calculator.
As a contractor
- Delivery Fees and Promotions: $24,000
- Tips: $26,000
- Total Money In: $50,000
- Expenses (30,000 miles @ 58¢) $17,400
- PROFIT: $32,600.
- Standard Deduction: $12,000
- Business Owner Deduction: $6,520
- SE Tax Deduction: $2,494
- Total Deductions: $21,014
- Taxable Income for Income Tax: $11,586
- Federal Income Tax: $1,390
- Self Employment tax: (15.3% x $30,203) $4,622
- California Income Tax: $637
- TOTAL TAXES: $6,649
- MONEY LEFT OVER AFTER TAXES: $43,351
As an Employee
- Minimum wage @ $12/hour: $24,000
- Tips: $26,000
- Vehicle Reimbursement (30,000 miles @ 30¢) $9,000
- Total Money In: $59,000 ($50,000 Taxable)
- Standard Deduction: $12,000
- Taxable Income for Income Tax: $38,000
- Federal Income Tax: $4,560
- FICA/Medicare ($50,000 @ 7.65%): $3,825
- California Income Tax: $1,630
- TOTAL TAXES: $10,015
- MONEY LEFT OVER AFTER TAXES: $48,985
So, yes, Frank paid more in taxes because he couldn't claim any miles. $3,366 more in taxes to be exact. That's a ton. HOWEVER, Frank has $5,634 more left over as an employee than as a contractor. How can that be?
Because receiving the reimbursement and not being taxed on that reimbursement, is more valuable than the reduction you get in the taxes for claiming your miles.
Okay, you say, that's not a good comparison. Frank didn't drive enough miles. A lot of people drive so much that they don't owe any taxes. Okay, so let's say Frank makes the same money, but now he drives enough miles to completely eliminate his taxes.
As a contractor
- Delivery Fees and Promotions: $24,000
- Tips: $26,000
- Total Money In: $50,000
- Expenses (86,250 miles @ 58¢) $50,025
- PROFIT: $0.
- Standard Deduction: $0
- Business Owner Deduction: $0
- SE Tax Deduction: $0
- Total Deductions: $0
- Taxable Income for Income Tax: $0
- Federal Income Tax: $0
- Self Employment tax: (15.3% x $30,203) $0
- California Income Tax: $0
- TOTAL TAXES: $0
- MONEY LEFT OVER AFTER TAXES: $50,000
As an Employee
- Minimum wage @ $12/hour: $24,000
- Tips: $26,000
- Vehicle Reimbursement (86,250 miles @ 30¢) $25,875
- Total Money In: $75,875 ($50,000 Taxable)
- Standard Deduction: $12,000
- Taxable Income for Income Tax: $38,000
- Federal Income Tax: $4,560
- FICA/Medicare ($50,000 @ 7.65%): $3,825
- California Income Tax: $1,630
- TOTAL TAXES: $10,015
- MONEY LEFT OVER AFTER TAXES: $65,870
So Frank has no taxes, and yet the difference between what he had left over before and what he has left over as an employee is $15,870.
And no, Frank really wouldn't have $65,870 OR $50,000 left over. That car is costing Frank a lot of money, a lot more than just gas. When you include gas and maintenance and depreciation, wear and tear – ESPECIALLY at 86,000 miles a year, a massive chunk of Frank's revenue is going back into that car. I should have put a car expense line in there, but the thing is the car is costing him the same thing whether he's a contractor or an employee.
In fact, I would argue it's costing him less as an employee. Because he's going to drive fewer miles. When Grubhub or Doordash is reimbursing you for your mileage now, you can bet they're going to be a lot more efficient in how they dispatch. In fact they're going to pretty well direct you from point to point, you can just about guarantee that.
So Being an Employee Would Eliminate the Mileage Deduction. But I thought you could claim un-reimbursed expenses?
There did used to be a deduction for unreimbursed business expenses. It especially would have helped the 86,250 mile Frank because he could have claimed the difference between the allowable 58 cents and the 30 cent reimbursement amount. Frank would have had to itemize to do this. However, under the new tax code, that deduction went away. Sorry, Frank.
Don't Give that Mileage Deduction Too Much Credit
It looks good in theory. However, extra miles don't do what a lot of contractors think they do. In an instance where being an employee and using your own car leads to reimbursement that you wouldn't have otherwise received, that's always going to be better than writing off un-reimbursed miles. Like I said, it's far more important to look at what's left over after taxes. I'd rather be taxed on a lot than have no tax on a little.
