W2 or 1099 or Incorporated?
Let’s compare them…
- Only option that allows you to join a group benefits plan (healthcare insurance, dental, vision, disability, etc.).
- Federal, state and local income taxes are automatically filed through payroll.
- Automatic monies go into your personal Social Security and Medicare (FICA) account through payroll.
- Automatic monies go into your unemployment insurance accounts (FUTA = Federal Unemployment Tax and SUI = State Unemployment Tax) through payroll.
- Clients prefer bringing on W2ed contractors because there is now liability coverage and they can separate themselves from any “employee-employer” liabilities.
1099 / self-employed independent contractor (IC)
- Income is reported on a Form 1099 to the government at the end of the year (no taxes are withheld).
- ICs are responsible for the entire percentage of 15.3% (= 12.4% [Soc. Sec.] + 2.9% [Medicare]) up to 92.35% of the net earnings from self-employment.
- The IC invoices the client and receives direct payment of the invoices.
- A law suit against you (an IC) could cost you the business’ assets and your personal ones as well. In fact, legally, there’s no difference between the two.
- Independent contractors are responsible for tracking all business expenses and income and for filing quarterly federal and state income tax payments. There is a risk of tax-evasion or fraud charges and penalties if you fail to state your corporation correctly or pay your taxes correctly.
1099’s are analyzed closely by the IRS because that is where a huge amount of unpaid taxes shows up.The IRS aggressively discourages the paying of individuals through 1099’s since most of those people will not have the money or motivation to pay all the taxes at the end of the year.
Need a Self Employment Tax Calculator? Click here to access a tool that helps you see to what level you would need to plan ahead and save money to pay the taxes you’re likely to owe the government. This tool can help you predict how much tax you would pay, based on updated 2010 IRS tax tables and codes. (http://www.surepayroll.com/calculator/self-employment-tax.asp)
Incorporated (S-Corp or C-Corp) or LLC
- Creating a corporation (technically a separate entity from yourself) requires expenses and time to file special papers, getting a (business) banking account, tax filing and the extra accounting and legal assistance.
- A corporation has better liability protection compared to a Sole Proprietor or Independent/1099 contractor.
- An incorporated contractor files a personal income tax return and the corporation files a corporate income tax return. The business expenses are itemized on the corporate tax return.
When a client pays an LLC as an independent contractor, they still need to be concerned that the single member of the LLC can be construed as a “Common Law” employee. Which would result in the client being responsible for all the back taxes (both payroll and Income) penalties and interest.
You may join Rothwell International
regardless of the business structure you choose.
If 1099 or incorporated, RIL will bill your client and collect your funds, sending you the entirety of the funds we receive from your client (exclusive of our fee). You are responsible for making all statutory tax payments to the government. You may be required to provide us proof of appropriate business insurances that your client demands of you (Workers Comp, Liability, etc.). This business structure is not eligible for our group benefits program.
As a W2 status, we bill your client and collect your funds, sending you the entirety of the funds we receive from your client (exclusive of our fee and statutory fees). You will have access to Medical, Dental, Life, and Disability insurances, General or Professional Liability insurance, Worker’s Compensation Insurance, 401(k) program, pre-tax expense reimbursement, automatic tax withholding.
Our advisors can help you determine if you are legally compliant to maintain a 1099 or incorporated status as a Contract Consultant.
It is urgently important to classify yourself correctly and the classifications need to be reanalyzed each time you take on a new project. The ramifications can be very costly!
If a Contract Consultant is found to be non-compliant with the guidelines (explained below), they will likely be reclassified as W-2 employees. The ramifications of this reclassification include:
- Losing your contract.
- Being liable for unpaid employer payroll taxes and fines.
- Directed to work as a W-2 employee of a third-party employer (such as a staffing company). This may result in less money as your billing rate will likely be adjusted to accommodate for the third-party’s mark-up.
- Your client could face significant penalties and will be subject to increased IRS scrutiny for years.
There are three factors that the IRS now focuses on to determine compliance (no longer does the IRS use the “20 Questions” test). These factors have to do with the degree of control clients have over the Contract Consultants. These three factors pertain to: behavioral control, financial control, and the type of relationship of the parties. Below are situations in each of these three areas that can dictate non-compliance.
Behavioral Control – You are typically considered non-compliant if:
- You are told where, when, or how to complete your work.
- You use your client’s equipment and/or facilities to complete your work.
- You do not have autonomy in selecting and managing sub-contractors you may use to complete your work.
- You are instructed by your client to complete tasks in a certain order.
- You are trained by your client.
Financial Control – You are typically considered non-compliant if:
- You are not marketing your services to other potential clients.
- You are not responsible for the profit/loss of your sole proprietorship.
- You are paid a fixed hourly wage rather than a set fee for the completion of a deliverable.
- You generate all or most of your contracting income from one client.
Type of Relationship – You are typically considered non-compliant if:
- You do not have a contract specifically stating that you are a contractor. (Note that the presence of such a contract does not automatically make you compliant if you do not pass the other criteria.)
- You receive employer-like benefits or insurances from your client.
- You expect a permanent or indefinite relationship with your client.
- Your services are considered a key strategic aspect of your client’s business.
Some clients do not allow 1099 contractors to work on site. If you come on board with Rothwell, you can maintain much of your independent status, but attain the status of W2 employment so that you can meet the client’s contractor requirements. You will also now have access to Healthcare Insurance, Workers Comp insurance, Professional Liability insurance, etc.
What if you are Incorporated?
Just because you are incorporated does not make you compliant by default. You still must show compliance with the IRS’s guidelines stated above. Misclassification can result in huge and potentially costly penalties.