W-2 vs. 109, which one you should take?
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 adviser, 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.
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. For more please go to: Consultants: Corp-to-Corp vs 1099 and a Salaried employee vs contractor.
