If I had option to choose between 1099 and W2 for my job, which should I choose?

Question

The only thing I know about the difference between 1099 and W2 is when you work as 1099 you don't pay taxes whereas W2 has to pay taxes for every paycheck I receive. As 1099 employee, I would have to pay big amount of tax at the end of the year.

So I thought it comes down to my preference of paying big amount of tax at one instance, or pay small amount of tax periodically. For which I would definitely prefer to be W2 employee and pay what I have to pay anyway from my paychecks.

Other than this difference, why should I work as 1099 or W2 employee? What are some factors that could benefit me from working 1099 rather than W2 or vice versa?

Answer 1

The important thing to realize is that as 1099 worker you are not really an employee. Instead, you are self-employed with your own business, and your "employer" is really your customer. There are several implications to this fact.

The company you are working for will be paying you money, but will not be giving you any benefits: no health insurance, no vacation or holiday pay, no retirement plan, etc. You are responsible to provide all of these things for yourself.

The company you work for will not be paying any taxes for you, so you are responsible for paying all taxes yourself. This includes sending income tax payments in to the IRS quarterly. Employers pay part of the payroll tax for their employees, but since you are self-employed, you need to pay all of it yourself.

There are other expenses related to having your own business that you might need to pay. For example, depending on your line of work, you might need to carry workers compensation or liability insurance.

All of this complicates your taxes quite a bit. If this sounds too complicated, you will want to find an accountant that can help you figure out what you need to do regarding paying your taxes and deducting business expenses.

When business slows down for an employer, often it is the contractors that are let go before the W-2 employees. Job security can be riskier as a contractor.

Having your own business can be rewarding, but is riskier and more complicated than being an employee.

Answer 2

As others have said, which is better depends on your particular circumstances.

From my own experience, if you work for a single employer, on site, I think you're better off as a W2 employee. (And could wind up being classed as one if the IRS ever audits you - their instructions have a number of tests you need to meet.) If you work mostly from home, and have several different clients that you do work for (or potentially could have), you are probably better off as 1099, since you can deduct many expenses - home office, equipment, occasional trips to client sites (but not daily commuting), and more.

You do have to pay taxes, which (barring the deductible stuff, which your employer would be paying for if you're a W2) are going to be the same either way. As a W2, you have taxes withheld with each paycheck, so no hassles on your part. As 1099, you need to file quarterly estimated taxes, which if your income is irregular, can be a bit of a pain. If you don't pay enough to cover your tax due* when filing your 1040, you will be subject to a penalty.

One other problem - the "Bernanke Trap" - might surface if you're thinking of getting or refinancing a mortgage. Mortgage companies are a lot more willing to lend if you can show W2 income, even if that income is a lot less than your 1099 income.

*There are "safe harbor" provisions, which IIRC are either 90% of this year's tax, or 100% of last year's. Check the IRS instructions to be sure.

Answer 3

1099 employees are not subject to withholding, but they do pay tax. Typically this is done in installments, 4 per year.

1099 employees may be able to write off certain expenses that W-2 employees cannot. They can also avoid some social security taxes which W-2 employees cannot. All of this requires some setup fees and there needs to be some working capital in place prior to getting their first pay check.

If this is a short term contract, then it is almost always better to be a W-2 employee. W-2 employees may be also qualify for fringe benefits, which have to be self funded as a 1099.

1099 employees may be able to contribute more to retirement and have more control over the investments. They also have to file costly tax returns.

Currently I am a 1099 and it is working out great. However, it has been long term, I am currently in month 20, and have been extended another year. Also I have a wife that provides benefits for me through her work. I can deduct from my profit certain expenses that lowers my income. Since I am setup as a corporation, I pay myself a smallish salary and take the rest of my profit as dividends from the corporation. This saves on a great deal of social security tax, but also reduces my earnings for social security purposes which might effect one negatively.

On the minus side, I pay about $800 per year to file my business taxes. Figure another 2500 in business taxes, insurance, and payroll fees.

On the plus side I am able to setup a solo-401K for no charge. I can come pretty close to putting in 50K per year if I desire. My investment choices are limitless and there is no fee. If I was a W-2 employee I could be limited to putting in ~22k, have poor investment choices, high fees, and may be subject to vesting on employer contributions.

So there is a lot of benefits, but it does not come without responsibility, management time, or costs. I just got smacked with a fee from the state because I did not file something on time.

It has to be right for you.

Answer 4

1. The company pays unemployment insurance fees for W-2 employees but not 1099 contractors. So if you're laid off, you can get unemployment if you were a W-2 but not if you were a 1099.
2. The company pays workman's compensation premiums for W-2 employees but not 1099 contractors. So if you're hurt while working, you get medical care as a W-2 but not as a 1099 contractor.
3. W-2 employees often get benefits. 1099 contractors rarely do.

4. The company deducts half your Social Security and Medicare taxes and pays the other half if you are a W-2 employee. If you are a 1099 contractor, you are responsible for paying both sides.

   Note that it may not be obvious how much is deducted from your paycheck. This does not appear on the 1040 form for W-2 employees. You have to look up the payroll taxes on your W-2 form. And remember that only shows half what you have to pay as a 1099 employee with the same pay. At least double it, and possibly more if your pay goes up.

   Another answer already noted that the rate is $62 per $1000 (6.2%) for each half of Social Security. For Medicare, the rate is $14.50 per $1000 (1.45%). That's $76.50 (7.65%) for them combined. And $153 (15.3%) for both halves. On the bright side, those taxes are deductible for the self-employed. So your Adjusted Gross Income (AGI) should only include 92.35% of the nominal amount. This all assumes that you make less than $100k a year. More than that and you may go above the Social Security level.

As a rule of thumb, I would insist on being paid 50% more as a 1099 employee. You are giving up a lot, so make them compensate you for that. If you are creating a business form (e.g. an S-corp or LLC), then that should increase to 100%.

Some people will say that I'm being too conservative with 50% and 100%. They may be right. It would be better to calculate the different benefits and costs so that you can work out the actual costs. The most important thing is to not accept the same pay as a 1099 contractor as you would as a W-2 employee. You should absolutely get some kind of premium. At absolute minimum, you need the 7.65% for the employer's share of the payroll taxes.

Don't forget that your taxes go up with your nominal income, not your effective income. So if you get a 30% premium, you pay your marginal tax rate of that as taxes. E.g. if you are in the 25% bracket, you only get 22.5% of that 30%. Unless of course you have offsetting expenses that are deductible.

Answer 5

I take it we're starting from the assumption that the amount of income is exactly the same in both cases? If not, then the question cannot be answered without knowing the difference in income.

If you're getting a W-2 you're considered an "employee". If you're getting a 1099 you're an "independent contractor".

As others have noted, W-2 employees normally get benefits, like company-paid health insurance, paid vacation, etc, that a 1099 independent contractor does not.

But I think the hard difference is this:

1. With W-2s, you have taxes withheld from your paycheck by your employer. With 1099s, you have to make quarterly estimated payments. Making the quarterly payments is surely a pain, but I suppose you could carefully calibrate the amounts to give yourself some advantage.

2. With a W-2, half of your social security taxes are theoretically paid by your employer, that is, they are not shown on the W-2 and are not counted as part of your gross income. With a 1099, you are responsible for both halves of your social security taxes. So if you get paid, say, $1000 on a W-2 versus $1000 on a 1099, with the W-2 the company is really paying an additional $62 toward your social security, on top of the nominal $1000.