Consultants: 1099 or W-2?

As a consultant or contractor, you can sometimes be faced with the decision when taking a new contract of whether to go 1099 or W-2.  Essentially, the question is in what manner will you be paid by your client.  Having faced that decision a few times myself, I will fill you in on my thoughts and how I try to compare the pay rates of both.  First off, definitions of both:

W-2: Usually the client has a head hunter, broker or other third-party service like a placement firm that will act as the intermediary between you and them.  You will receive wages from the broker with the requisites taxes withheld, so you are essentially an employee of the broker.  The broker in-turn invoices the client for your services (with a markup).  Some brokers will provide you with medical and dental insurance options, life insurance, Section 125 flexible spending and even a 401(k) plans.  As a W-2 you only get paid when you work, so you might want to think of this as a “Hourly W-2″.  If you are getting a salary with benefits, you are not a W-2 but rather a salaried employee (see Salaried employee vs contractor).

1099 (Self-Employed Sole Proprietor):  A sole proprietorship is an unincorporated business that is owned by one individual.  You submit an invoice to the client or broker and are paid without any taxes withheld.  You will receive a 1099-MISC each January from your client indicating the payments made to you for the previous calendar year (hence the term “going 1099″).  Please be aware that the IRS might still consider you an employee and disallow your independent contractor status, even though you are paid via 1099.  See IRS Publication 1779: Independent Contractor or Employee? and Consultants, know how the IRS determines employee status.  If this were to happen, the company you work for would owe back payroll taxes, so some companies prefer W-2 to avoid this situation.  As with a W-2, you only get paid when you work (see Salaried employee vs contractor).

Now for the pros/cons of each:

W-2:

  • Don’t need to submit invoices (no bookkeeping)
  • Employer pays their portion of taxes, and they withhold your portion of the taxes
  • Employer may pay part of health insurance
  • Limits on the deduction of unreimbursed business expenses (amount over 2% of your adjusted gross income) and health insurance premiums (amounts over 7.5% of your adjusted gross income)

1099:

  • Need to submit invoices (more bookkeeping)
  • Most contracts specify “30-day net”, meaning the client has 30 days to pay you after they receive your invoice.  That means you need to have enough money in the bank to go at least 30 days without getting paid!
  • With W-2 you are pretty much guaranteed to get paid by the client.  With 1099, you could have issues collecting payment
  • You must pay self-employment taxes (social security and Medicare tax).  This is what is usually paid by the employer when you are W-2.  THIS IS THE BIGGEST DIFFERENCE BETWEEN 1099 AND W-2: You have to pay 7.65% in extra taxes!
  • Need to be diligent and save money each paycheck so you can pay quarterly taxes (estimated taxes each April 15th, June 15th, September 15th, and January 15th). I would suggest setting up a cash reserves account and having money automatically transferred each month into that account
  • Can deduct more business expenses, like a home-office deduction (see IRS Publication 587, Business Use of Your Home) and full cost of health insurance premiums on the front of your 1040 (but these expenses don’t reduce your self-employment taxes).  See IRS Publication 535, Business Expenses for all the details on what’s deductible and what’s not, as well as 101 Tax deductions for bloggers and freelancers
  • You can defer more current income into retirement plans than you can with W-2, thereby reducing your income taxes (see IRS Publication 560, Retirement Plans for Small Businesses).
  • Unlimited liability for the owner
  • Be aware that there could be a BIG difference between paying for medical insurance via W-2 thru a broker and paying on your own via 1099.  The broker would likely be paying for a portion of the medical insurance, where going 1099 you would pay for all of it.  Insurance costs are crazy and a self-employed heath plan with a high deductible will cost you at least $500/month for a family plan (and were talking a $7500 individual deductible with no maternity coverage, no pre-existing condition coverage, and a required health background check…insane).  See Health Insurance Options for Independent Consultants
  • If you setup an S corporation, you can have your invoices payable to the S corp instead of you.  Then, you don’t have to pay the self-employment taxes.  However, as an S corp, you need to pay yourself a salary, in which you have to pay employee and employer taxes.  But you can also setup an individual 401k and contribute to that in order to lower your taxable income.  Additionally, if you take this route than you are paying less into social security and will therefore receive less when you retire (if social security is still around).  So there are tradeoffs that you should discuss with your accountant.  Something to think about

So how do you compare the rates for 1099 and W-2?

Since you have to pay self-employment taxes with 1099, what would be the equivalent pay rate for 1099 be compared to W-2?  Let’s break out some math, using 2011 IRS rules.  As an employee, for each pay check you pay 5.65% in taxes (4.2% FICA, 1.45% Medicare).  Your employer pays 7.65% in taxes (6.2% FICA, 1.45% Medicare).  But if you are self-employed (1099), you have to pay BOTH the employee and the employer taxes, which is 13.3% (10.4% FICA, 2.9% Medicare).  This is called the self-employment tax.  In essence, you are paying an extra 7.65%.  However, you only have to pay FICA on the first $106,800 of your earnings.  Anything over that and you only have to pay medicare.

So let’s see how much more you have to pay as a 1099.  Let’s assume you are a very well paid consultant making $200k/year.  You will be paying an extra 6.2% FICA on the first $106,800, which totals $6621.  You will also be paying an extra 1.45% Medicare for the full $200k, which is $2900.  So adding $6621 and $2900 gives the total amount of extra taxes you will be paying: $9521.  Assume you will work 2000 hours in a year, that results in $4.76/hr.  So your 1099 rate would need to be $4.76/hr higher than a W-2 rate to equal out.

But there are a few other things to consider.  You need to compare the cost of medical insurance via W-2 thru a broker and on your own via 1099, unless you are covered thru your spouse.  If not, let’s assume you would pay $375 W-2 and $500 1099 for similar insurance (taken from my experience).  That means you would need to make an additional $0.75/hr to make up the difference.  Added to the $4.76/hr and you are up to $5.51/hr more for 1099 over W-2.  At the expense on confusing you more, the other thing to think about is that you can deduct half of your self-employment tax in figuring out your adjusted gross income come tax time.  You can also deduct the full cost of health insurance.  Assuming you are in the 35% tax bracket, without repeating all the calculations, that equates to a tax savings of $5,046/year, or $2.52/hr.

So in the end, if you subtract the $2.52/hr from $5.51/hr, you are left with $2.99/hr as the amount you need added to the W-2 rate to equal a 1099 rate in this example.  Hopefully this will give you some guidance to substitute your own numbers and accurately compare the two when faced with your own decision to go 1099 or W-2.

So armed with this info, if your are working with a placement firm, ask them the rate you would be paid as a W2 versus a 1099.  I have even worked with a placement firm that paid the same either way, so of course I took the W2 option!

Hope this helps.  I also compared 1099 and W-2 to two other options: Consultants: Corp-to-Corp vs 1099 and a Salaried employee vs contractor.

More Info:

Consultants: W-2, 1099 or Corp-to-Corp?

Calculating Corp-to-Corp Rate vs W2

About James Serra

James is SQL Server MVP and a independent consultant with the title of Business Intelligence/Data Warehouse/Master Data Management Architect and Developer, specializing in the Microsoft SQL Server BI stack.
This entry was posted in Career, Consulting, SQLServerPedia Syndication. Bookmark the permalink.

36 Responses to Consultants: 1099 or W-2?

  1. Jeff Wilson says:

    Interesting blog post but the overriding choice of whether one is W2 or 1099 is the Scope of Services in the Contract. In order to qualify for independent contractor status you must have a large degree of autonomy from the employer. They should not be able to control your schedule or activities. I know you touched on this with your reference to the IRS posting. As a consultant, a lot of it involves being the master of your opinion. I will not allow a client to tell me which application should be used for a specific task, I will be open to suggestion but I retain the right of final decision.

  2. Ken Stockwell says:

    I just stumbled on this post and really appreciate the time and effort you put into it. I’m currently a consultant employed directly at a mid sized consulting company but have been thinking about going it on my own. This information is very useful to me as I evaluate contract opportunities in the future.

    Thanks,
    Ken

    • James Serra says:

      Glad to help Ken. I’m working on another blog that compares Permanent/Salaried/Full-Time vs Contractor/Consultant (W2 or 1099). The conclusion will be you can make a lot more money as a contractor/consultant :-)

  3. Pingback: Salaried employee vs contractor | James Serra's Blog

  4. Peggy says:

    I am confused about deducting expenses for 1099. As a 1099 contractor am I subject to nonreimbursed expenses @ 2% of AGI? Or are my eligible expenses deducted directly from AGI on 1040? My company is reorganizing and offering us option to stay on as 1099 instead of W-2 but I am stuck on this as my spouse has a decent salary so if I am working PT/1099 and can’t deduct expenses until they reach 2% of AGI that might make a big difference.

    • James Serra says:

      Hi Peggy,

      As a 1099 contractor I don’t believe you are subject to the limit of nonreimbursed expenses at 2% of AGI, but I strongly suggest talking with an accountant so it is clear.

  5. Larry Eccleston says:

    In October of 2011I hired in to a company I had worked for in the past. I had worked both as a consultant and as a full time employee. This time they said they were not hiring consultants but they would put me on what they called temporary part time. There were no benefits but they would pay the taxes and FICA. I discovered later they were also paying into a retirement program through Fidelity. My total take is well over $100,000 plus I am on Social Security. My boss has mentioned putting me on as a full employee but he can’t get approval for a position at that level.

    As I am working my way through my taxes I wonder if I can call myself a contractor or am I actually a full time employee without benefits. I do a lot of work at home and have a seperate office and would like to claim all the expenses. I could save a lot in taxes if I could call myself a contractor.

    In January they changed their mind and I am now working through Manpower so next year the game changes again.

    Any Thoughts,

    Larry

    • James Serra says:

      Hi Larry,

      Find yourself a good accountant to deal with your questions. I found a great accountant who has saved me much more money than if I tried to do my taxes on my own, not to mention saving me a ton of time.

  6. Pingback: Consultants: Corp-to-Corp vs 1099 | James Serra's Blog

  7. Susan says:

    James,

    Thanks very much for walking through the cost analysis of W2 vs 1099. Your points seem consistent with what I’ve experienced in the past, and helped me define my salary requirements for 1099 job leading to full salaried job.

  8. rike says:

    Another downside of 1099 … no unemployment.

    • Andrew DeFaria says:

      Not really, you can and should pay into unemployment. You can pay yourself a paycheck and have them pay all of the required taxes including unemployment insurance. That’s what I do as a corp – I’m sure a 1099 can do likewise. I have Wells Fargo and they provide this service for like $50/month (AKA $0.30/hr).

  9. Kevin says:

    Thanks James for taking the time to write this. Based on this can you suggest if my move to move from W2 to 1099 is justified.

    I get paid at 60/hr and my employer take flat 20% and gives me 48 dollars per hour on W2 with a 4 dollar tax free per diem. I pay my full insurance which is before tax

    With moving to 1099 will I be paying 13.3% in self employment taxes or 50% of that. And considering that I pay my own insurance I might be better off doing 1099 based on the self employment taxes

    W2: For 170 Hours @60 (Employer paying 48 with $4 per diem and me paying insurance) = 6400
    1099: For 170 Hours @60 with paying 750 dollars of insurance what would my net come to?

  10. Pingback: Blueprint for consulting riches | James Serra's Blog

  11. ed says:

    Jamie – This is very helpful. I’m currently working as a w2 consultant for the first time, and am considering taking another offer, but it’s a 1099 contract. I knew I would be paying my own taxes, including the part paid by the employer in a w2 situation, but didn’t have this level of detail. Great information!

  12. jess says:

    I just graduated with my Masters degree and got an internship for a small start-up company. They are paying me as an independent 1099 contractor (no taxes withheld). They are paying me a set amount for the total contract, though I work a typical 40 hr week. It’s a 2 month contract and it expires in a few weeks.

    It was intended to be contract-to-hire and I feel optimistic based on my contributions so far. Since I’m nearing the end of the contract, I’ve been trying to research what I should expect when we renegotiate my pay. I’m not sure what the complete benefits package is yet, so I will have to determine its value, subtract that from my current rate, and set that as a minimum expectation. Would that be fair? It’s my first contract job and hopefully my first FT w/ benefits position. It seems as though W-2 an apples-to-apples switch to FT and 1099 is quite different. This article sets me on the right foot..thanks!

    Another Question:
    - Since my contract is only 2 months, will I still have to pay the next quarterly taxes in January?

  13. Matthew Thomas says:

    A material fact is whether you might be subject to an additional tax category as an independent contractor, i.e. in Hawaii most likely you will be liable for the 4% General Excise Tax on gross income, which is applicable to almost all transactions.

  14. Carmen says:

    I was hired and never was told by the owner that I got paid $40 per diem but if the commission was more than the per diem he would pay commission instead. $40 a day for 7hrs came to less than min. Wage. I never received an explanation of how I would get paid just instructions regarding responsibility in dealing with Customer purchases.
    He call his employees Consultants and give them 1099′s. However store hours are posted in front of the store (10 am to 5pm). I recently quit this job because he would not paid my sister for her hours. Knowing that we were working together. He accepting her employment application and mine. He still owes his commission for the month of October.

    What is your opinion regarding our disbut? Paying less than min wage. Per diem is a real estate term he came up with.

    We look forward to hearing from you. We live in California.

  15. Samuel says:

    Great information, thanks! The question I have is regarding state taxes. Are there any state tax implications in 1099 vs. W2? I know state taxes/tax law vary by state, but perhaps you may know a general yes/no to the question.

    Also, I’m trying to flip the order in the above comparison rate example because I’d like to know what I would need to make on a 1099 to equal out my current W2.

    • James Serra says:

      Hi Samuel,

      I have been lucky and have not had to deal with state tax, but I would expect it would work just like federal tax, where the employer pays their portion if you are W2, but you pay the employers portion if you are 1099.

  16. Oliver says:

    If you have not worked all year and was just offered a freelance/temp job for Dec (and on into 2013)… but for the current tax year, I will only be working one month…. earning about 8K. is it better to go W2 or 1099? If I recall, there was a min of $5000 for SS/MC for 1099? Or was that a max?. i don’t want pay over 1/2 of that in SS tax if i do 1099 for that one month? but would rather for the long run so…. Any help?

  17. Pingback: Consulting company: Perm/Salaried vs 1099/W2 - SQL Server - SQL Server - Toad World

  18. Mark berron says:

    Hopefully this blog is still operating. It is very informative. Now, my situation. I am 57 and have not built up enough for retirement, which is in 401ks. I have recently obtained employment with a small company who after initially calling me an independent contractor, gave me a letter stating the wage, >$100/hr, that I was a W2 employee, but that I wouldn’t be eligible to participate in any benefits, 401k, etc. Well, my health is covered by my wife, so no sweat there, but I have a problem with my retirement. I have to build it up, but won’t I be limited to just the IRA? I mean, I will now have sizable taxable wages and no way to reduce the taxes. Thanks, Mark

    • James Serra says:

      Hi Mark,

      There are other ways to build your retirement besides your IRA. There is an individual 401k and SEP (simplified employee pension plan) as two possibilities. You can also create your own company and start a 401k. Talk with a good accountant about your options.

  19. Andrew DeFaria says:

    The so called self employment tax is not the only advantage to working 1099 (or C2C). As a business there are various expenses you can write off that you will not be able to do once you sign onto a W2 position. Things like home office deducation, meals and expenses, business expenses like insurance, internet, etc. are all not available to you because you’re essentially an employee when you’re on W2. As a single guy without the wife, kids and house to supplement my tax deductions, my business deductions are all I have. For me to go W2 will mean I will have to shut down my perfectly profitable business and lose all of those deductions.

    Additionally, as an S corp, there are additional tax savings as you pay yourself a salary which is taxed much more heavily than the tax you pay on the remainder of your corp’s revenue. Granted reporting requirements are much higher so you should get yourself a good CPA. Mine costs me about $1500/year but even in the first year he saved me like $15-$17K so it’s well worth it.

    Additionally, you must ask yourself exactly what quality of healthcare and other benefits are you gonna be receiving from essentially this new employer and more importantly how long will this relationship last?

    I’ve been consulting off and on for some 25 years now. And it’s been my exact experience that I have never, I repeat NEVER, been placed a second time by the same consulting firm (‘cept my own corp that is). So if this is a 6 month contract with the possibility of extensions you must first throw out that possibility of extension as that’s not in writing – IOW assume it won’t happen – and then think that all of those benefits and things like 401K plans will be going away. You’ll be looking for new healthcare insurance, etc. You probably won’t vest in the 401k plan and many companies won’t match contributions until say 6 months or a year. So you get absolutely no extra benefit from your W2 employer’s 401k plan except the wonderful duty of a having to roll it over once they boot you out the door. That and you’ll be stuck with the meager choices that restrict your selection of 401k investment options to a bitter few. Instead open up an IRA and be open to 3000 or more mutual funds that you can choice from.

    It used to be when you were employed by a consulting company that if your current assignment ended you’d be “on the bench” making a somewhat reduced salary from the consulting firm until they placed you again. This was their incentive to get you working again and bringing in $$$ for them. That’s no longer the case (why did we allow that to disappear?). Now you get “W2 with no benefits” to which I always ask “What’s the point?”.

  20. Pingback: Independent consultant: How to find work - SQL Server - SQL Server - Toad World

  21. Justin says:

    Hi James,

    Just came across your blogs and this is what I’ve been looking for a long time. I’d really appreciate your times and your knowledge on this. I’ve been working as a salary employee in my whole life for 15 yrs. I also had side contract as 1099 to my S Corp a few years ago but it’s closed now. I was always afraid to go for contract full time as it’s not stable and I can’t afford a couple months off. But after reading your post, I think I would try it now. I’m making 120K/year with 15K medical/dental paid by the company, and 3 weeks vacations, 11 holidays, 10 sick days. Do you know if a 1099 contract rate of $80/hr would be a fair start for me?

    Thanks,
    Justin.

  22. Pingback: Forcing a contractor to go W2 - SQL Server - SQL Server - Toad World

  23. Pete Flynn says:

    Working now as an independent contractor on a W2 job. Is it possible for my wages to be paid to me in the name of my corporation

  24. The one thing missing here is the cost of business insurance. That also has to be factored in as it is not required for W2 employees.

  25. Frank leguizamon says:

    Hi James,

    I’m working under a 1099 form and was hired for a job, it’s been over 60 days and I still haven’t been payed by the contractor, their delayed was making the invoice. what do you suggest I do?

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>