Self-Employment: How Many Hats Do You Wear?

“What’s this?” I yelled, scattering receipts every whichway off my desk. It was April 15th of my first year in business. I looked at the screen again. I owed a HUGE amount to the IRS. At first I was sure it was a glitch in the new tax software I’d bought. But it wasn’t. I’d just been KO’d by a one-two punch by the IRS—the self-employment tax and the quarterly estimated tax payments.

I went in search of information. Why was the SE tax so high? What was a SE tax? And why did I have to pay estimated taxes up front if I was self-employed?

The quarterly estimated tax question was pretty easy. As an employee I’d had to pay withholding because the IRS wanted to be sure I had the money to pay my tax when it came due. I figured the quarterly estimated tax, which is paid in advance just like withholding tax, was based on the same principle, only for businesses.

But what was that expensive SE tax? I’d ascertained that it had nothing to do with my income tax calculated on Form 1040. In fact, I had to pay the SE tax in addition to my income tax. I finally discovered SE referred to my Self-Employment Social Security and Medicare tax. But why was it so much? I knew employees only paid about 7.5% for Social Security tax. Why did I have to pay nearly twice that?

The answer I found down at a nearby bookstore was mindboggling. The SE tax was so high because now that I was self-employed, I had to pay both the employer and employee portions of Social Security/ Medicare tax of about 15% for me.

This split by IRS accountants of an individual into two parts, employee and employer, seemed “crazy” to me back then. I wasn’t two people. I was just Nancy Humphreys.

I resented the tax. Why should I have to pay twice as much as an employee pays?

This, of course, tells you my mindset. I thought of myself simply as an employee rather than as business owner. The distinction between being self-employed versus being a business owner is something I read about when I came across Robert Kiyosaki’s Rich Dad, Poor Dad 2: The Cash Flow Quadrant. His comments in that book about self-employed people shocked me, and hit a nerve at the same time.

As I read more about owning a business, I came to realize how useful a tool the IRS’ “two-people-in-one” method of looking at self-employment was. I began to use that idea to examine my business in terms of costs and benefits. The IRS’ principle of two hats (employer and employee) helped me examine two problems that I had when I first went into business for myself.

Problem # 1 When calculating how much it would take to go into business for myself, I wore only an “employee hat.” I thought of all the benefits that not going to work would bring. No more lattes and lunches out, no more gasoline or time wasted in commuting, no more closet full of professional clothes, etc. I never even thought of the “employer hat” costs of running a business. As a result I underestimated the true costs of a home business.

Problem # 2 I didn’t have a model for estimating my real business costs. This led me to overestimate my salary as an indexer.  That too led to frustration. I kept feeling I wasn’t really earning enough, and I didn’t know why.

Both of these problems began to seem manageable as soon as I began using the IRS “employee/employer in one person” tool to look at my business.

I was amazed to find out how many costs my employers had borne on my behalf while I was earning a paycheck. Seeing how many “hats” my employers wore was key to seeing my costs, necessary costs apart from doing indexing, that you should think about in relation to your work.

A model for determining how many hats  you wear

As I’ve said, those in business for themselves, even if it’s a solo practice, wear two hats: employee and employer. Employees, whether self-employed or working for others, rarely see the whole extent of the employer benefits we receive.

Employers wear many other hats. Here’s my simple model for how to see yourself as an employer if you’re self-employed OR how to understand the total employer benefits you receive if you’re a salaried employee.

As an example of my model, I’m going to walk you through my last place of employment, a small two-story non-profit that employed about 25 people. You’ll need to follow me through this example, then make up your own way of walking through your memories of a workplace you know well.

In this model, “hats” refers to job titles of employees. I’ve given these job titles an initial capital. You’ll also see the various duties belonging to each job. I’ve underlined and numbered the duties that you need to take care of in order to support your indexing work.

The public face of the organization

At the front door was the Receptionist. We didn’t get a lot of walk-in traffic, so the Receptionist mainly (1) fielded the phones. The Receptionist also (2) ordered supplies for everyone in the building and kept the supply cabinet stocked.

Across from the Receptionist’s desk was the Director (or CEO). The Director was responsible for (3) setting the mission and goals for the organization, (4) the budget, and 5) being the “public face” of the organization to the outside world. The Director also led weekly staff meetings. The Director had four Associate Directors and an administrative staff. The Associates had other functions, but also served as sounding boards when the Director needed feedback.

The rest of the administrative division

Down the front hall and turning to the right was the rest of the administrative division.

The Administrator of this division was mainly concerned with (6) employee benefits. These included disability, health insurance, life insurance, worker’s compensation, and retirement benefits. About thirty percent of our salaries were paid in benefits. The Administrator also supervised the other employees, including the Receptionist, and handled large purchases for the division.

The Accountant and Bookkeeper managed the financial paperwork and worked yearly with an outside CPA to review the books. They handled (7) invoicing and payroll, withholding and other (8) tax forms, and ((9) kept track of the income and expenses along with assets and liabilities of the organization.

The Administrative Assistant supported the rest of the division, and (10) maintained the phone system used by the receptionist and all the employees. This AA also assisted me in (11) maintaining the network of computers, printers, faxes, and other equipment. (Later the Accountant took over that job!)

The information services division

Down the front hall and to the left on the first floor was me, the Library Director. Along with managing the computer network, I also served as an Associate Director who assisted the Director.

I had four employees who worked under my direction: a Librarian; an Administrative Assistant; a Library Aide, and an Indexer.
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In the library, our job was to (12) locate information the other employees needed to do their jobs. We also served groups of people our employees worked with in the outside world. For example, we created a thesaurus and put out an annotated bulletin each month that summarized articles from all the magazines we subscribed to. 13) Besides ordering books and magazines, the library was also the place where supply catalogs and professional reading materials were ordered and organized for all staff.

The line staff of the organization

In the back hallway on the left and on the second floor were all the “line” employees of three main primary divisions of the organization. The line employees performed the primary functions of the organization.

The three main divisions of line staff were: a) local community organizing, b) national media relations [and they also handled (14) marketing for the organization itself], and c) an international pilot project.

Work contracted out

Maintenance was performed weekly by an outside (15) cleaning company.

This model as a model

Now, please don’t misunderstand. I’m not saying the above model is an ideal organizational model. As you might have noticed, several people held positions in two different divisions, an ambiguity that often causes problems in organizations.

In addition, the usual position of  COO (chief operating officer) was left empty. No one had responsibility for (16) coordinating all the support and line functions for the organization, a lack that led to the closure and reorganization of the organization a few years after I’d left it.

Where do indexers fit into this model?

If you are a self-employed indexer, you are a line employee. You produce the product of your organization. If you work as an indexer within an organization, you may be a line employee, a support staff member, or your position may be a hybrid one similar to the indexer who worked  for my library. That indexer produced an annotated magazine database and newsletter which were used both by line employees within and clients outside of the organization.

If you’re a self-employed indexer, you can use this model to see what your employer expenses are and begin to track the amount of time you spend while wearing employer hats. If you’re employed at an organization, you might do this walk-through in your own workplace to uncover all the support staff you benefit from or to find where you need more support to get your work done.

Ok Nancy, I see your point about all the “hats,” but exactly what does this mean for my business?

Using the above model and tracking your time, you can easily calculate your” employer costs” of being self-employed or being an employee.

If you look above, you’ll see that I’ve underlined 16 chief support functions at the place where I used to work. These are your “employer costs” of indexing. That’s true whether you work alone, or you operate a business which hires other employees to index with you, or you work in a large organization as an indexer.

If you work at an organization like the one in my example, consider what the numbers of underlined duties above mean. Over half of the organizational staff in my model were support staff. If you work in an organization, you are actually receiving support from the majority of the support staff at your workplace. You get way more benefits than insurance and retirement from your employer!

On the other hand, if you are a self-employed indexer, or you’re an indexer who employs other indexers, you probably don’t have any support staff. Instead, you’ve got at least 16 employer-hat-duties to take care of by yourself. The duties performed while wearing these hats are ones that do not directly concern your main business of indexing. But these things must be done so you keep on indexing or keep owning your indexing business.

And if you are self-employed, the numbers of employer duties under the hats in the model described above suggest this: at least half of your working time will be spent in support staff functions rather than on indexing itself. Each of these 16 employer duties entails costs! Most importantly, these costs include the amount of time you spend while wearing employer hats.

How many of us actually track all of those “employer costs” when we estimate our worth? If we do track these costs as labor time, how do we price our labor? Do we price it at what we earn as indexers? Do we price it at what we’d pay if we hired someone else to do those tasks? Or…do we price our time spent on employer tasks at zero?

NOTE: This article was published in advance of my workshop talk titled “How Much Are You Really Worth” for the American Society for Indexing conference in Portland, Oregon, April 24, 2009.

Copyright © 2009 by Nancy K. Humphreys