1099 vs. W2: Which Do You Choose?

Is the grass greener on the other side? Who really wins when it comes to a 1099 vs W2?

This is a guest post by Dr. Barbara Hamilton who blogs at Tired Super Heroine. She is an interventional radiologist who writes about the challenges of being a physician and mother. 

I was an employee and received a W2 during my first three years out of training. At the time, I was working in private practice as a diagnostic and interventional radiologist in California. Working for a national company, I was told that I did not fit the definition of independent contractor (IC), since I had little control over my schedule (sob!). The practice managers felt that IC status would not stand up to IRS scrutiny in my case. Eventually, the radiology company was bought out. As a result, I started working as an IC.

Here are some things I have learned in my first year of earning a 1099 and forming a professional S-corporation.

Different Employee Benefits

While salary is often the first thing people consider when it comes to employment, understanding the different benefits that come from 1099 vs. W2 work is key.

Stability in W2 Work

A co-worker of mine has chosen to remain a W2 employee for the sake of simplicity. He counts on a paycheck every 2 weeks. He does not have to keep track of separate corporate accounts or itemize business expenses. Consider whether you value the simplicity of being an employee over the increased responsibility that comes with self- employment.

Will your status change whether you must pay for your own malpractice coverage? My current group provides malpractice coverage for employees and contractors alike. This may not be the case for you. Liability coverage would be a large business deduction for a 1099 earner, but it would also be a significant expense to account for when negotiating increased 1099 wages.

Evaluating Benefits Packages

As an employee, you receive a benefits package, which has monetary value beyond the salary provided. Often, one of the most significant benefits is access to employer sponsored group health insurance. I was not thrilled with our plan options as an employee, and I still paid a significant amount of the premium. A group life insurance policy was provided free of charge, but it was inadequate on its own. Group disability insurance was provided, but the benefit would be limited to one year, so I still needed my own long term disability policy. Given these factors, the benefits offered were not compelling enough to keep me as a W2 employee.

As an IC, I now see that healthcare options can also be limited due to geographic constraints. Premiums run about $1000 per month for my family of three. We do not qualify for a government subsidy, so we have an off-exchange PPO. With an S-corp, I am able to deduct premiums from our personal return. A C-corp, on the other hand, can deduct these as a business expense. This deduction will be of questionable benefit for us. Previously, I paid half our premiums via payroll deduction. The healthcare equation may look different for you. For example, being employed at a large academic institution, you may receive truly excellent coverage or even free healthcare, as I did during fellowship. This is a valuable benefit for some employees.

Retirement Benefit Options

Some W2 earners will receive a match to their 401k contributions. I received Safe Harbor contributions as an employee, amounting up to $10,600 one year. However, 401k contribution limits were $18,000 in 2018. This limited my ability to decrease taxable income. As a 1099 earner and business owner, I can contribute to a solo 401k as both the employee and the employer, with a combined contribution limit of $55,000 this year. This larger contribution limit will allow me to significantly reduce my taxable income, and more than double my 401k savings rate, even accounting for the Safe Harbor contributions I will lose. This is one of the most compelling reasons I chose to switch to IC.

Professional Development and Continued Learning

As an employee, you may get a stipend to pay for continuing medical education, CME. This is a wonderful benefit because it is money on which you do not pay income tax. This makes it worth more than if you simply added it to your total compensation. I did not receive a CME stipend as an employee. As an IC, I can now easily deduct airfare, lodging, course fees, and other CME related expenses on schedule C.

Revised Tax Law Implications

Standard deductions for personal income taxes have risen with the new tax law. These are now $12,000 for individuals, and $24,000 for married couples filing jointly. This means that if you are paying for any unreimbursed business expenses as an employee, it will now be even harder for you to recoup any money in the form of a tax deduction.

As an IC, I plan to deduct many business expenses. Filing a corporate return this year will increase the cost of tax preparation by $700. That is deductible. Some of the other deductions I’m utilizing include a new cell phone, internet service, and a home office. The latter includes a portion of our homeowner’s insurance and utility bills. Some meals are deductible. A corporation can purchase or lease a business vehicle. A large vehicle with a gross weight of 6000 lb can be fully depreciated in one year, making the purchase price deductible in that tax year. Paying your kids to model for your website can be deducted as a business expense. One can even rent their own home to the corporation for work related events.

Understanding Cash Flow in 1099 vs. W2 Work

As an employee, cash fluctuations are minimal. Paychecks arrive every other week. The employee doesn't need to take direction action since payroll deductions are taken automatically.

My company pays independent contractors monthly. Therefore, there is a longer period between checks, and the checks are larger. Since 1099 earners do not have payroll deductions taken from their income, they must pay estimated quarterly taxes. For many, these payments are large. I have paid estimated quarterly installments ranging $7,000 to $20,000 each, between state and federal taxes. I contribute lump sums to my solo 401k.

These factors can result in wild fluctuations in the corporate account, with periods of depleted cash reserves. As an employee, taxes and expenses are relatively out of sight, out of mind. As an IC, on the other hand, you have both the control and responsibility to make these expenditures, and thus are fully aware of their cost and their effect on your cash flow.

Getting Going as an S-Corp

A new business entity must be registered with the state in which it is headquartered. The optimal business entity may vary based on where you live and work. I chose an S- corporation. The application was submitted by my accountant. In the case of an S-corporation, the company must be registered as a C- corp prior to electing S- corp status. I don't make the rules. Consult your CPA.

Creating an EIN

Your corporation has an Employer ID number, or EIN, which is used as the entity’s tax ID number. When money comes into the corporation, it must be associated with the EIN, not your social security number. Likewise, the EIN is needed to set up business accounts, which are separate from your personal accounts.

Any business account bears the name of, and is owned by the corporation. This structure is required to ensure the money earned receives appropriate tax treatment. Early in the year, I made the mistake of opening a personal account for the business, not associated with my EIN. I later spent a couple of hours at the bank correcting my mistake.

Payroll Decisions

In an S-corporation, a corporate payroll is required. This costs $35 per month with an online platform I use. But note that many payroll companies charge far more. My accountant, for example, charges $80 per month, or $960 per year for this service. Payroll is a deductible business expense, but it remains beneficial to minimize it.

You need to pay your employees a “reasonable” salary. Basically, a reasonable salary is the amount you could theoretically pay someone to replace you. Some estimate this should be 30- 50% of 1099 earnings for the primary employee, say a doctor in this scenario. Using a pass through entity such as an S- corporation, you will save FICA taxes on the remaining income, which becomes corporate profit. You will still pay state and federal income tax on all corporate profit.

Running the Tax Numbers

Run some numbers. As an IC, you will pay self- employment tax, additional accounting fees, and registration fees. The state of California taxes corporate profits at 1.5% with an $800 yearly minimum franchise tax. I wanted to be sure that forming a corporation would reduce my tax liability enough to be worth the trouble because of these additional expenses. My accountant charged $500 to run some theoretical numbers through his accounting software, generating reports of various scenarios. The most important variables are the salary one chooses, and the anticipated corporate profit. Employing a spouse or other family member is an option. This involves paying extra payroll tax for that employee, but it allows them to contribute to their own retirement plan.

I found that the estimated yearly tax savings projects in the five to ten thousand dollar range for my family. Five thousand dollars multiplied by many working years, compounded over time, can add up to a large sum. Therefore, the benefits of being self- employed, relative to the effort required to learn about it, may be greatest early in one’s career. I feel I’m getting the most “bang for my buck,” since this knowledge will benefit my family for years to come.

Final Thoughts On 1099 vs W2 Work

Philosophically, I feel that becoming a 1099 earner and corporation CEO (yes, you really can have that title) has started to change my way of thinking to that of a “business owner.” Learning about my business entity relatively early in my career will allow me to optimize this strategy over time. Additionally, I appreciate the ability to control factors like benefits and business deductions. In order to embark on the self- employment path, one needs a desire to learn about the mechanics involved, and to find a team of qualified professionals to assist. This is not a do it yourself project. Even with help, I will not do everything perfectly the first year. But I’m looking forward to seeing how we did in 2018.

Please note, if you are considering Public Service Loan Forgiveness (PSLF) you should not become an independent contractor. To qualify for PSLF, you must be an employee of a non-for-profit institution.

If you want to connect with Dr. Barbara Hamilton at Tired Super Heroine on social media, you can connect with her on Facebook, Twitter, and Instagram.