unemployment-freelanceMy friend announced that she and 300 co-workers found themselves facing unemployment, as their jobs were outsourced less expensively overseas.

Companies tightening their belts often will eliminate employees and hire contract workers, whether directly (freelancers) or indirectly (overseas). Employees mean payroll taxes, workers compensation insurance, sick days, holidays, vacation days, and other benefits, including health insurance. Because of this, employees cost companies 25 percent to 50 percent over their wages.

Therefore, some employers take shortcuts and only hire freelancers. When that’s the only job available in today’s economy, what are you going to do? You’re going to take it.

If you go from employee to freelancer, what will change?

More cost. You must pay self-employment taxes of 7.65 percent (your boss’s share of Social Security and Medicare) as well as your own share of Social Security and Medicare (5.65 percent in 2012).

More recordkeeping. If you are a freelancer, you must keep books and records, and your tax return will cost more. You must file a Schedule C with your tax return, and, if your employer insists you form an LLC or corporation, you will need to file a business tax return.

More tax danger for Schedule C filers. If you’re working like an employee, but getting paid as a freelancer, you’re not entitled to most of the business deductions self-employed people claim. When your day-to-day work is at the employer’s facility, you’ll have a commute of business miles, but commuting isn’t deductible. Your cell phone is not deductible; most of the cost is the base monthly fee, and only charges for specific business calls are deductible. Because you’re using your boss’s tools, supplies, equipment, and so on, a computer or other supplies you may try to deduct won’t survive under audit—not even in Tax Court.

What to do if you are forced to work as a freelancer?

You have three choices:

1. Do nothing. Be grateful you have work.

2. File a Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. With this, the IRS will be invited to examine your employer’s hiring practices and determine whether you are an employee or not.

Note that if you take this route, your employers will be contacted, and it is likely they will not be happy. You may get fired or they may make your life so miserable you’ll want to quit—and quitters don’t get unemployment insurance.

3. Include Form 8919 – Uncollected Social Security and Medicare Tax on Wages with your tax return. This allows you to pay only your share of the Social Security and Medicare taxes, saving you 7.65 percent on your business income. (On income of $30,000, that’s a saving of nearly $2,300.)

If you take this route, you must include the aforementioned Form SS-8 to explain why you’re an employee—uh oh!

For folks who don’t want to rock the boat, there is a fourth option. You can file as a freelancer, paying the taxes until you’re not working at that particular job anymore. Then you can amend the last three years’ tax returns to include Form 8919. You’ll get back the employer’s share of Social Security and Medicare, perhaps with interest. This isn’t a nice thing to do to someone who may have treated you well in other respects, but you may find yourself with no choice.

Ideally, the best option is for employers to take responsibility and treat employees correctly. In the long run, by doing so, employers will face fewer audits and penalties. In fact, the IRS has a special amnesty program (VCSP) to help employers get back into the system.

Eva Rosenberg, EA is the publisher of TaxMama.com , where your tax questions are answered. Eva is the author of several books and ebooks, including the new edition of Small Business Taxes Made Easy. Eva teaches a tax pro course at IRSExams.com and tax courses you might enjoy at http://www.cpelink.com/teamtaxmama.