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I've in the middle of an offer for employment. During negotiations, I've asked for more money due to distance involved (Further by far than I'd normally consider, but the pay raise I'd get is basically double what I'm making now).

Lets say I was offered $45 an hour as a W2 employee. They said they are moving offices and it's further away from "home" in the near future. I said that I need more money (Time + gas) to compensate.

The response is basically "We have a ceiling of $48 an hour for W2 employees... but we can go $50 for 1099."

I've never dealt with being a 1099 employee. What benefits and pitfalls should I be aware of? I don't know what questions to ask or where to start. What will I gain as a W2 employee, at a smaller paycheck? 1099 at a marginally larger paycheck?

Ultimately, the question is given those two options: $48 W2 vs $50 1099, what should I choose and why? I'm not averse to going "contractor" but it's a new area and I don't want to screw myself over on a marginal difference.

20

Careful.

I would personally need a LOT more than $5 more per hour to go from W-2 employment to 1099 employment.

It boils down to two reasons: (1) employers pay a huge amount of taxes on behalf of their employees, and (2) you would have to pay all of your own withholding up front. Your current proposal from them doesn't account for that. There are also risks that you face as a 1099.

On the first item, your employer currently pays 6.2% of your Social Security tax. You pay the other 6.2%. If you go to 1099 status, you will be self-employed as an independent contractor and have to pay the full 12.4% out of your increased 1099 wages.

On the second item, your employer also does your withholding out of your paychecks based on what you tell them on a form W-4. If you're disciplined enough to pay this out yourself in estimated taxes every time you get a paycheck, great. Many people aren't and just see a much bigger paycheck with no taxes out of it, and end up with a large tax bill at the end of the year.

Overall, there are some other considerations like healthcare and other benefits. These will not be available to you as a 1099 employee. You can also be terminated spontaneously, unless you have a specific contract length with the company.

As I see it, not including any benefits you would receive, you're looking at LESS money in your pocket at $50/hr as a contractor than at your $48/hr. Your pay net social security deductions is: $48 x 40 hrs x 52 weeks = 99,840 * .938 = 93,649.92. As a 1099 @ $50/hr you would net $50 x 40 hrs x 52 weeks = 104,000 * .876 = 91,104.

Then there are the rest of taxes, etc to figure out your real take-home pay.

I'm not a tax advisor, but I would be very careful to get the whole picture figured out before jumping. I would ask for a lot more with the added risk you would take as an independent, too.

  • 1
    This more or less verifies what I was reading since I asked - 6.2/12.4. I think I might be able to go down the contractor road at some point, but definitely not over a $2/hour difference. – WernerCD Sep 17 '13 at 16:49
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In general that's illegal. If you're a W2 employee, you don't miraculously become a 1099 contractor just because they pay you more. If your job doesn't change - then your status doesn't change just because they give you a raise. They can be sued (by you, and by the IRS) for that.

Other issues have already been raised by other respondents, just wanted to point out this legal perspective.

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    I don't think OP is talking about negotiating a raise, but rather is applying for a new position. I don't see anything wrong with them offering a W2 or 1099 option for a new employee/contractor. – JohnFx Sep 17 '13 at 17:15
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    @JohnFx if a position is a W2 position - they cannot legally offer him a 1099 contract. If its a contract position - they cannot hire a W2 employee (because if they could - see above, they couldn't have offered 1099 to begin with). The pay is not what can be used to distinguish between W2 and 1099 positions, and from the OP question it is clear that that's what they're doing. Its illegal, and he can sue them years later for the backpay of all the taxes and benefits he is not getting as 1099 but would have gotten as W2. – littleadv Sep 17 '13 at 17:16
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    @WernerCD so that's the point - they cannot do that. – littleadv Sep 17 '13 at 18:42
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    This is the kind of information I was looking for - an answer I never expected. I'll have to add this to my consideration. I have no desire to end up in the courts, so it would definitely put a damper on "turning" this into a 1099. But really, a big enough company can't have the same job available for both options? I can see a technical company benefiting from being able to hire "employees" or "contractors" for the same position? – WernerCD Sep 17 '13 at 18:51
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    The IRS has a litmus test for 1099 contractors. If you work in a acompany office on company-owned equipment under the direction of a company manager, you are almost certainly not eligible to be a 1099 contractor. That said, many companies do it anyways, and the @WernerCD is hardly the first (nor last) person to be offered this choice. – stannius Sep 17 '13 at 20:13
10

In general

  • the W2 employee will also get some benefits: Holidays, sick/vacation, insurance, 401K (which might include matching). the company also covers the employer portion of social security.
  • The 1099 will get X dollars an hour for every hour they can bill up the the maximum number of hours they are allowed to bill. They get zero benefits. The individual is responsible for both parts of social security.

What does this mean? Assume 10 holidays and 2 weeks of vacation. So you will report to the office for 240 days (48 weeks * 5 days a week).

If you are a w2 they will pay you for 260 days (52 weeks * 5 days a week). At $48 per hour you will be paid: 260*8*48 or $99,840.

As a 1099 you will be paid 240*8*50 or 96,000. But you still have to cover insurance, the extra part of social security, and your retirement through an IRA.

A rule of thumb I have seen with government contracting is that If the employee thinks that they make X,000 per year the company has to bill X/hour to pay for wages, benefits, overhead and profit. If the employee thinks they make x/hour the company has to bill at 2X/hour.

When does a small spread make sense: The insurance is covered by another source, your spouse; or government/military retirement program. Still $2 per hour won't cover the 6.2% for social security. Let alone the other benefits.

The IRS has a checklist to make sure that a 1099 is really a 1099, not just a way for the employer to shift the costs onto the individual.

  • I've been reading a little of the same, although I hadn't found much on insurance/vacation/etc. As a contractor, that would make sense and would steer me away from that option for a $2/hour difference. Would also explain some of the higher paying opportunities I've seen. – WernerCD Sep 17 '13 at 16:51
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    It is possible to be a W-2 contractor. In that case the employer pays half of the employment taxes but doesn't give any other benefits. Even if that's what the offer is here, it's still not worth it. The $2 doesn't even cover the social security taxes. It it's a choice between full employee at $48 (or even $45) and 1099 employee at $50, then it's not even close to worth it. – stannius Sep 17 '13 at 20:10
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Another thing to consider, however, is the deductibility of business expenses. Let's assume that the employer can legitimately hire you as a 1099 contractor. (Would you be able to telecommute? Would you have a high degree of control over when you worked and when you didn't? These factors also affect whether you're a true independent 1099 contractor or not.) As a legit 1099 contractor, you're able to deduct certain business expenses directly from your income. (You can find a list of the rules at irs.gov.) As a W2 employee, by contrast, can deduct only business expenses that exceed 2% of the your AGI (adjusted gross income). So, you also have to consider your personal circumstances in making the calculus and comparing whether a legitimate 1099 contractor job is or is not good for you. It's not just a comparison of what they'd pay W2 employees versus what they'd pay 1099 contractors.

  • Welcome to money.SE! Please read the tour page when you have a chance too. Stick around! – John Bensin Sep 26 '13 at 18:06
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    As an employee - you're not expected to have business expenses at all. As a contractor, you're likely not to be allowed deductions for your car if an office is provided by the employer (which from the sounds of it will be). That would be commute, and is not deductible. When an W2 employee is "re-characterized" as 1099, there's not much he can gain by deductions, unfortunately. – littleadv Sep 26 '13 at 18:07

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