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I opened up a Roth IRA in June of 2018. I was originally paid $6,000 as a contractor (with a 1099). I put $5,500 into the Roth IRA. I then thought that I wouldn't be able to use a Roth IRA with a 1099, so I asked for it to be changed to a W-2 which it was.

My first question is whether this was a good move or not? Would I still have been able to use a Roth IRA with a 1099 and what would be the benefits/repercussions of using a 1099 vs Roth IRA (I have read something about fica being paid for partially by the company when I am under a W-2, but I'm very confused).

Furthermore, my payment came in as $3,776.86 after tax. I hadn't realized that I would be taxed so much since that was all of my income. I am filing as a dependent of my father, so is that why my tax rate is so high or did something go wrong?

Lastly, do I need to pull money out of my Roth IRA since I only earned $3,776.86 post-tax or is the contribution limit of earned income in an Roth IRA applicable to the $6,000 not the post-tax amount?

Thank you so much. I've done a lot of research and can't get a solid understanding.

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Self-employment income is generally reported (to the IRS, with a copy to you) in Form 1099, and you need to

  • report this income on Schedule C which you attach to your Form 1040

  • pay Social Security and Medicare taxes on the (net) self-employment income (you compute this on Schedule SE), and you have to pay both the employee's share as well as the employer's share (since you are the employee as well as the employer) of the Social Security and Medicare tax.

  • include the net income on Form 1040 (there is a separate line for this, don't include these amounts on the Wages line of Form 1040)

If you are employed by someone else, you still have to pay your share of Social Security and Medicare taxes (the employer deducts these from your paycheck) but the employer pays the employer's share. You don't get to see what the employer paid as the employer's share (that is, this is not shown anywhere on your W-2 form) but the employer does tell you what was deducted from your paycheck and sent to the IRS on your behalf.

But, to cut to the key question, self-employment income entitles you to contribute to a Roth IRA (as long as your total income is not too large -- high-income folks cannot contribute to a Roth IRA at all). If you contribute to a Roth IRA during the year and later (while filling out your tax return) discover that you actually are not entitled to contribute to a Roth IRA because of high income, you should back out the contribution or tell the IRA custodian to treat the contribution as a contribution to a Traditional IRA instead of a Roth IRA. -- one can always contribute to a Traditional IRA regardless of high income, but high-income folks cannot deduct the cntribution.

Now, if you earned $6000 as a W-2 employee instead of as a contractor (1099), you are entitled to make a Roth IRA contribution as if your income was $6000, and so a $5500 Roth IRA contribution is OK (provided you can borrow the difference between $5500 and $3776.86 from your parents or have savings that can be used to make up the difference).

  • Thank you so much for the detailed response! This helped a ton. – Eric Wiener Nov 15 '18 at 1:51
  • Tiny addition: FICA is the law under which the employer pays its half and withholds your half of Social Security and Medicare, so these together are often called FICA taxes. The self-employed equivalents are technically SECA, but since they are (by design) the same amounts, people sometimes call them FICA also. Also, you report SE (net) income on 1040 but also get to deduct half of the SE tax when computing income tax; this is (again by design) equivalent to the way for an employee the employer's half of FICA is not counted as income on your W-2. – dave_thompson_085 Nov 16 '18 at 17:47
  • Oh, and also: contractor compensation is reported on 1099-MISC, and is one (common) kind of self-employment income, but there are many other kinds of self-employment income that are not reported on any variant of 1099, but nevertheless are taxable in the same way. – dave_thompson_085 Nov 16 '18 at 17:51

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