A 10% down-payment on a $500,000, 2 bedroom condo is $50,000. Saving that much would require putting away $1041 a month for 4 years. 4 years away feels like a very long time.

But in 4 years I’ll only be 31. My 31 year old self would probably want to take my 27 year old self out for a beer and thank me profusely if he looked at his savings account balance and found $50,000. Of course, between then and now, there’ll probably be a lot of plane tickets and other unplanned spontaneous large expenses to account for. So saving $50,000 might take a little longer.

In 4 years Stephanie and I will have paid around $72,000 in rent. In 4 years I don’t know what “beginner” condos will cost in the city, I don’t know where we’ll be living or where (or if) we’d want to buy, and I don’t know where Stephanie or I will be working. So I probably shouldn’t be envisioning a condo in San Francisco, but rather one in the next place we live.

Wherever that is, a $450,000 30 year 6.3% fixed rate mortgage costs $2785/month, or $1200 more than we currently pay in rent. One hopes that in 4 years we could comfortably afford that. The funny thing is that $2785×12×30 = $1,002,600. It costs $552,600 in interest payments over 30 years to borrow 450,000. Wow, that is striking.

Things that would be worth paying $1200 more each month for: covered parking for 2 Vespas and/or a Smart Fortwo (or other city car). A washer and dryer in the apartment. A second bedroom. An outdoor space or balcony with room for a grill.

After doing my taxes this year, I wondered if self-employed individuals are at a disadvantage when it comes to paying federal taxes.

I didn’t profit off of my self-employed venture (i.e., this blog) when I factored in the cost of web hosting and cable internet, but anyone who makes a profit of more than $400 owes a 15.3% tax on 92.35% of that profit in order to cover their contribution to Social Security and Medicare. But based on a survey of my past W2s, Social Security and Medicare account for only about 7.65% of my gross income. What gives?

So I set out to test my theory that the federal government imposes a financial disincentive on self-employment. In order to do so, let’s invent two people: Sally and Jim.

Sally works for company X. In 2006 she earned a salary of $50,000.

Jim is a consultant. He often works many different jobs as an independent contractor, but in 2006 he worked solely for company X and invoiced the company for a total of $50,000 over the course of the year. Jim’s work expenses are minimal. Other than getting to and from work (usually walking), company X provides him with office supplies, workspace, and a computer.

When Sally fills out her 1040 form, she enters $50,000 from her W2 in the line marked “Wages, salaries, tips, etc.”

When Jim fills out his 1040 form, he enters 0 in that line, because all of his income was reported on a 1099-MISC form. He instead fills out Schedule C-EZ (Net Profit from Business), and considering his negligible business expenses, he enters all 50,000 in the line marked “Business income or (loss).”

Sally has no deductions, so her Adjusted Gross Income remains 50,000.

Jim, however, has to fill out schedule SE (Self-Employment Tax). His total earnings were $50,000, which he multiples by 0.9235 to figure what the government considers his net earnings: $46,175. His self-employment tax is 15.3% of that, or $7,065. He then deducts one half of that, $3,533, from his gross income, giving him an Adjusted Gross Income of $46,467.

Sally takes the standard deduction plus one exemption (subtracting $8,450 from her AGI), leaving a taxable income of $41,550, and bringing her total taxes for the year to $6,951, or 13.9% of her gross income.

Jim also takes the standard deduction plus one exemption, leaving a taxable income of $38,017, and bringing his taxes to $6,064 plus his self-employment tax from Schedule SE of $7,065, for a total tax burden of $13,129, or 26.3% of his gross income—almost twice that of Sally.

However, there are two things that Jim did not have deducted from his earnings that Sally did. Social Security and Medicare. Sally’s Social Security tax rate is 6.2%. Over the course of the year, she had $3,100 deducted from her paycheck for that. Her Medicare tax rate was 1.45%. A total of $725 was taken out for that.

So in total, Sally’s take home pay was:

Whereas Jim’s take home pay was:

That’s a staggering difference of $2,353, nearly 5% of Jim’s gross income. That, it would seem, is the aforementioned financial disincentive, or the cost of Jim’s freedom (depending on how you look at it). I’m not joking (about the latter) either. The IRS says you are considered an employee if “the employer has the legal right to control the details of how the services are performed.” Does Jim really have to pay the government a fee of $2,353 every year for the simple freedom to determine “what will be done and how it will be done”?

That seemed strange to me, so I did a little research on the self-employment tax. According to the IRS website, the SE tax is indeed a means to levy the Social Security and Medicare taxes.

Self-employment tax (SE tax) is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners.

The 15.3% SE tax consists of two parts, 12.4% for social security (old-age, survivors, and disability insurance) and 2.9% for Medicare (hospital insurance).

But still, based on my past experience (where I got the 6.2% and 1.45% figures above), the SE Tax rate is double what actually gets deducted from my wages. They go on to say that:

you can deduct half of your SE tax in figuring your adjusted gross income. Wage earners cannot deduct social security and Medicare taxes.

Though in my example above, that only amounts to a tax relief of $887 for Jim (Sally’s tax of $6,951 – Jim’s tax 6,064 = $887).

I wonder if historically self-employed persons were seen as more of a burden on Social Security and Medicare after they stop working, whereas in the past many employers had pensions (now 401(k) plans), and medical plans, thus reducing somewhat the overall public burden of their employees.

This page describes the Social Security & Medicare Tax Rates from 1937 to the present, and contrasts the rates for employees vs. the self-employed. The difference between the two hasn’t always been so severe. That changed in 1984. Stephanie suggested that maybe the employer pays the difference, confirmed by this site:

Employees have half that amount deducted from their pay, and they may feel they are paying less because their employer picks up the rest. However, when an employer looks at the cost of hiring you, he considers total cost, including payroll tax.

Turns out Sally’s 50,000 salary really includes a hidden payroll tax paid by the employer, making her true salary something like $53,825 ($50,000 + $3,100 + $725). So what if Jim had invoiced Sally’s company for $53,825. How would they compare then?

Turns out they’re pretty much the same. In the end, it appears there is no financial disincentive for being entrepreneurial, even though from the perspective of someone who’s self-employed, it may feel that way, especially when looking at a wage-earner’s advertised salary. This is exactly the opposite of what I had expected to find. I set out to prove a disincentive, and ended up disproving it.

…taking a test where you’re encouraged to cheat, but in order to do so you have to fill out more forms. Which kind of integrates the punishment with the reward.

Apparently tax programs make it really easy to cheat, but I’m ideologically opposed to paying someone else for that privilege, especially since I’m childless and houseless—making taxes an apparent walk in the park for me. As an aside: shouldn’t software that helps people pay less taxes be free and open source? Oh wait: TaxGeek.

My life should be all 1040EZ, except for those Google Ads you’ll see on my post pages if you come in from outside the site. This year I netted $695 from Google, reported to the government as non-employee compensation (1099-MISC). Last year the amount was less than $400, which I considered not worth my time to even look at Schedule C and SE. Of course last year I had the pleasure of filling out all my tax forms twice (1040, CA, and NC) in order to demonstrate the additional tax burden of a surprise bonus (in the form of moving expenses), but that’s neither here nor there.

So now there’s Schedule C-EZ, where I get to report how much I made minus my expenses. And if the difference (aka PROFIT!) is more than $400, I have the great honor of paying taxes on that amount (roughly 15%). So the game of being in business for yourself comes down to: finding expenses. The reality probably is that I spend a lot more on my blog than I think (e.g. $278 to resurrect the laptop I’m presently using), so much so that I bet could take a loss on this little blogging enterprise of mine, and then deduct that loss from my actual salaried income. But that means filling out more longer forms, and frankly, I’ve got better things to do with my time.

By my rough estimates, web hosting cost me $120/year and cable internet cost somewhere in the neighborhood of $600/year. The part that gets me is that I don’t have to explicitly defend these expenses. I just say my expenses were $695, making my profit from blogging a sad $0. Here’s the good news. Google sent the government $195 on my behalf. Which I can report as part of my federal taxes already withheld, and which bumped me from owing $105 to getting a refund of $61. How you like them apples?

Something changed when I got to San Francisco. Even though living in a city for the first time was an incredible challenge, I felt in some ways more settled and more stable than in Santa Rosa.

Thus several chores that had been on my plate for a year or longer suddenly decided they were ready to be done. One of the big ones was saving. I’ve always had a savings account, and I’ve been reasonably good at putting surplus money in it every month, but my saving and spending habits usually follow a pretty predictable pattern. At certain points, usually once or twice a year, my savings account would “fill up”, and then I (or necessity) would decide I needed to spend it on something. Like a new laptop. Or a car. Or plane tickets. To me this felt like very practical saving. Rainy day saving. The only downside is that occasionally I’d draw it down to near zero—which meant no more rainy days, at least for a while. But I’m young, right?

Then things changed. When I started working for the State of North Carolina, I was required to put 6% of my paycheck before taxes into the state retirement fund. This was the first money set aside that I couldn’t touch for pretty much forever. A few months into my year at O’Reilly, I signed up for their newly restarted 401(k) plan and decided to set aside 15% of my income. I liked the idea of seeing how little I could get by on. The only problem was that my rainy day savings account started to dry up—a few hundred dollars at a time as I paid off my credit card bill each month.

It wasn’t long until I started my current job at Federated Media, and since I expected to be relocating a few months later, I stopped saving for the long term to weather the near term burden of overlapping rent, deposits, and start up expenses. The other end of the bargain (I made with myself) was that I wouldn’t just stop saving altogether. I was pretty insistent that I’d start putting money away automatically again by the end of the year.

In early October I read Jeremy Zawodny’s post, Following Scott Adams’ Financial Advice? A database geek at Yahoo, writing about how he stacks up against the 9-point personal finance plan devised by the comic-strip artist of Dilbert fame, after CNN Marketwatch ran a piece suggesting this advice was worthy of Nobel consideration. What? Talk about stand up and take notice. Surely the best recipe for grabbing [my] attention is passing off the absurd as entirely normal.

Well it worked. It was the kick in the ass that got me learning about what the heck an IRA was (why can’t it be simpler!?), eventually creating both a traditional and a Roth IRA account through Schwab, and finally jumping though necessary hoops to get the money I’d left in North Carolina and at O’Reilly into my new accounts.

But the part I’m most pleased with is that my rainy day savings account has slowly been recovering to the point where I was able to fund my Roth IRA for 2006. It certainly isn’t the same as if I was putting away 15% of my gross salary, but it definitely made me feel like I’d been able to weather all the change and upheaval of the past year while still managing to save a little for the distant future.

One last thing. My experience with Schwab so far has been exemplary. I spent close to an hour on the phone with one of their representatives discussing my IRA options. The online account creation process was incredibly smooth, and a few days later I got a call from a person (who gave me his name and extension), welcoming me to Schwab and offering every available assistance as I get started. And they’re a discount brokerage! They sent me the information I needed in order to free my money from North Carolina, and the paperwork they’ve sent me in the mail at each stage of the process has been complementary to their services and helpful. What a refreshing surprise.

Update: Learning how to save, one year later

last night when i finished checking my email, i slid my new laptop under the bed to prevent anything falling or stepping on it. i then proceeded to lean across my bed to plug the alarm clock back in (the plug had fallen out of the wall), and my foot caught the edge of the laptop and i stepped on it.

i heard a snapping noise, i assumed it was just from lid hitting against the base, and i went to bed.

this morning i woke up late and decided to check to see if i had any work emails, and i discovered a plus-shaped crack in the upper-right of the screen with a few bleeding pixels. brand new laptop less than a month old with a beautiful 14″ screen, marred by my clumsy foot.

estimated cost for repairs: $895. just thinking about feels like having the wind knocked out of me, repeatedly.

as you can see, it looks much worse with the winxp blue background than just plain white. i count about 100 dead pixels (out of 1,470,000).

update: make that $495 of pain. after getting quoted prices like $895 for the replacement and repair from ibm, and $700+ labor from UNC, i decided to do a little searching around (ebay, google) and discovered that there are some outfits that sell just the LCD screens–you know for people like me who step on theirs.

after doing some research into the guts of my laptop, i discovered LCDS 4 LESS had the screen for my laptop at a much reduced though still painful cost of $495. they also said it only takes about 15 minutes to install. so i’m going to do it myself, and then probably put up the busted but working LCD panel on ebay.

update: see replacing a laptop lcd screen for my write-up of the process.