Employee or Contractor? How 1 Client Saved $30k in Taxes with 1 Phone Call
Employee or Contractor? How 1 Client Saved $30k in Taxes with 1 Phone Call
5 considerations for any W2 Employee who is considering 1099 Contract work to save taxes and manage the complexities of a business.
This is a shorter post available to everyone where I want to share a common question and my answer. I’d like to share these insights as situations come up in my work with clients that I think will be relevant to others.
Disclaimer: My goal in these articles is to simplify the complex and help you take the next step in your financial situation. As such, this is not a comprehensive deep dive into every possible nuance or strategy. This article, like all my resources, is intended solely for educational purposes and should not substitute for specific investment, financial, or tax advice. Always consult a qualified tax professional for guidance about your tax situation.
I talked with a client the other day about a common question I receive:
Should I be a W2 Employee or a 1099 Contractor?
The answer saved him over $30k in taxes on only $200k in income.
Our conversation went on for the better part of an hour as we discussed the pros and cons of each, but the right answer to this question was pretty obvious for him after just a few minutes.
I’ve condensed the most valuable and relevant parts of this discussion so that you can make the best choice for your situation and (hopefully) save a good chunk in taxes.
Consideration #1: What Does the IRS say?
We discussed the legal classification for W2 vs 1099 and why sometimes you simply aren’t given a choice. See the IRS guidelines here for more information.
The Department of Labor has just issued new guidance which is under scrutiny in the courts right now. Their guidelines are more stringent than previous rulings, but is still helpful to understand. You can find more information here.
Consideration #2: Taxed on Gross or Net Income?
W2 employees earn wages, pay taxes, then pay expenses with the money leftover.
1099 contractors earn wages, pay expenses, then pay tax on what is left over.
This difference in timing and calculation of taxable income is the single greatest factor that results in 1099 contractors paying far less in taxes than their W2 counterparts.
Believe it or not, the savings aren’t just for the individual, but also for the company paying that individual as they are no longer on the hook for Employer taxes of 8-10% or more. This means that you may even be paid more because they have more available to cover your cost!
Consideration #3: Tax Strategies
W2 employees have very few tax strategies they can take advantage of besides retirement contributions and tax-free health coverage.
1099 Contractors unlock hundreds of tax strategies including deducting a variety of expenses, depreciation benefits, self-managed retirement, Augusta Rule rental deductions, home office, travel (think Hawaii for annual business meetings), S Corporation SE tax savings, etc.
Consideration #4: Complexity
W2 is the simplest way to go… but simple doesn’t mean cheap. It costs you in taxes. W2 employees can usually file with H&R Block or Turbotax.
1099 is more complicated. You have to:
Start a business
Learn about tax filings
Learn how to manage your business finances
Learn about what you can and can’t expense
Most likely need to hire a tax accountant to help with their personal and business return filings
As with anything in life, you get out what you invest in. The ROI on this learning can be significant and compounds every year.
Consideration #5: Benefits
W2 employees get benefits like health insurance, retirement, vacation, sick pay, etc.
1099 Contractors get benefits like autonomy, flexibility, ability to work with multiple clients, self-managed retirement, etc.
The end result for my client was savings of roughly $30k more in his pocket on $200k in income by becoming a 1099 contractor instead of a W2 employee.
I’ve had many similar conversations over the years and have had clients choose both options based on what best suited them.
What do you think? Have you made this choice? How did it turn out for you?
Do you know anyone trying to make this decision? Please share so that others can learn how to be more strategic with managing their tax preparation.
Questions or further thoughts? Feel free to drop them in the comments and we can dive deeper!