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Occasionally when applying for a job, the employer will offer you the ability to be a 1099 Contractor, or a W2 Employee. Which should you choose? It really depends on your goals and current situation.
Below is an outline of the pros and cons with each work structure.
A 1099 Contractor will generally have more freedom than a W2 Employee, without having set hours and a specific work location. Employees will generally have their work & hours more regulated.
Contractors generally receive no benefits, while Employees may receive insurance benefits, a 401k match, and Paid Time Off.
Employees pay 7.65% for FICA (Social Security and Medicare) through payroll taxes. Their Employers pay the other 7.65% of the 15.3% total. However, Contractors are responsible for “Self-Employment Taxes”, which is essentially the Employer and Employee portion of FICA; so they pay the full 15.3% However, Contractors only pay taxes on their net income (see “Deductions” & “X-Factor” sections below for more).
Since 2018 Tax Reform, the IRS no longer allows Employees to deduct expenses. However, Contractors are able to lower their net taxable income by any expenses they incur, such as a home office, business use of vehicle, cell phone, meals, supplies, etc. For example, a Contractor may have the same $40,000 pay as an Employee. But if each have $5,000 in expenses, the Contractor will only have $35,000 in taxable income versus the Employee’s $40,000.
The 2018 Tax Reform brought about another huge change that affects the Employee vs. Contractor decision, and that’s the Qualified Business Income (QBI) Deduction. This new QBI deduction allows eligible self-employed/business owners/Contractors to deduct up to 20% of their qualified business income on their taxes. In general, total taxable income in the 2022 tax year must be under $170,050 for single filers or $340,100 for joint filers to qualify. In the example of the Contractor having $35,000 in taxable income after expenses, that Contractor would get an additional $7,000 QBI deduction (since income is below limits, assuming other income doesn’t push out of range). This would bring taxable income down to $28,000 for the Contractor, versus $40,000 for the Employee, which more than makes up for the Self-Employment taxes.
While Employees have withholdings taken out of their paychecks for FICA, Federal, and State Taxes, Contractors have no withholdings taken out and must make Quarterly Estimated Payments to comply with the U.S. “pay-as-you-go” system.
In the end, the decision comes down to what’s important to you. Do you need benefits? Will you have a lot of deductions? Will your total income from all sources fit below the QBI deduction qualifying limits?
Feel free to contact us with questions as it pertains to your specific situation…we’re happy to help!