Please note: this article is written in November 2018 before final forms and instructions may be available for federal and state 2018 returns. It is based on what is known at this time.
People often want to know if it is better to be on a W-2 or a 1099. Sometimes employers dangle the prospect of deductions that employees can take if they are 1099 freelancers versus if they are on a W-2 in front of the employee. They neglect to say that the employee goes into the employer’s office every day and are actually employee’s according to the IRS; if the employee will go on a 1099, the employer doesn’t have to pay half the social security costs, unemployment tax, and workers compensation costs. That doesn’t include possible health insurance and retirement costs.
What I compare here is the example of the person who actually is an employee, has an office at the employer’s, uses the employer’s equipment, and has no deductions. She would not be able to take home office (as she might think she can). Why not? Because her employer provides an office. She cannot take going from her home to the office as a deduction. Why not? Whether a 1099 freelancer or a W-2, people generally cannot deduct commutation costs.
Let’s compare a single person, living in NYC, with no dependents who earned $50,000 in 2016.
|federal income tax||
|employee taxes, fica|
|federal income tax||3119|
|federal income tax and self employment tax||10184|
|1099 excess costs||1476|
The W-2 employee pays a total of $12,204 in taxes while the 1099 person pays $13680. This means that the 1099 pays $1476 more to be on a 1099.
Does this mean that 1099 people pay more for social security taxes (known as self-employment taxes for self-employed people)? They themselves pay more. W-2 employees get credited for a matching payment by their employers which in this case would cost the employer $3825.
Am I saying that every person would save $1476 if they are W-2 versus 1099? No, I’ve given this example because it’s comparing apples to apples.
Each person, particularly those who genuinely have deductions should fill out a sample tax return as if they are a W-2 employee and then another one as if they received 1099’s.
Some considerations for each person to think about:
- Actual tax comparison like the one given above
- Previous to tax year 2018, a consideration would be deductions that they might legitimately take as a W-2 person versus what they might take as a 1099 person. Someone who has a lot of deductions including actual home office use could pay less overall as a 1099. Often if they really have a lot of deductions, they may actually be a 1099 freelancer versus being a W-2 worker as in the above example. Additionally, someone who has high deductions has limits put on them (amount over 2% of unreimbursed business expenses on Schedule A) and possible alternative minimum tax ramifications. Often people in the entertainment business have agent fees, management fees, and legal fees that make it worthwhile for them to incorporate to take advantage of more of these expenses. Starting tax year 2018, W-2 deductions will no longer be deductible. Please note that as of tax year 2018, business expenses for a W-2 are no longer allowed to be taken on a Schedule A. This plus the new qualified business income deduction of up to 20% is making people think they should switch to a 1099. Please be careful. The IRS has already issued regulations that people who have worked as a W-2 cannot take the 20% qualified business deduction if they previously have been on a W-2. Please see “Freelancers and the Tax Cuts and Job Act of 2017”
- Benefits that 1099 freelancers might be forgoing like unemployment, workers compensation, and health insurance. Flex plans aren’t available to 1099 freelancers.
- 1099 freelancer requirements to invoice for each payment
- Time lag for payment for 1099 freelancers. Is payment immediate or on a 30 day (or more) net schedule?
- Getting paid at all: a W-2 worker knows immediately if their paycheck isn’t coming. 1099 invoices sometimes aren’t paid, and it could take a long time to discover that.
- 1099 recipients have to be responsible for tax payments. This means paying estimates or quarterlies four times a year. There may be penalties if these payments aren’t made. Please see “Estimated Taxes for Freelancers” on this site. https://www.freelancetaxation.com/estimated-taxes-for-freelancers
- Control over money. Some people like to feel they have control over their money. Being a 1099 freelancer gives that to these people. They have to determine if that feeling is worth the extra expense that being a 1099 freelancer might cost.
- Running a business: the IRS expects recordkeeping for 1099 freelancers. W-2 people generally do not have such requirements.
- 1099 people have the ability to defer more of their income into retirement funds.
- Extra taxes. I got a call from someone who gets paid $80000 as a W-2 and grosses $50000 as a 1099. She wanted to know if she should become an LLC in order to get paid all her money as a 1099. She was unaware that in NYC, she might be subjecting herself to two additional taxes: the MCTMT tax and the NYC Unincorporated Business Tax. Once she heard that there was a tax on unincorporated business tax, she asked about being incorporated. I then told her NYS and NYC had taxes on corporations. She decided to keep her situations the way it is.
- Liability. A 1099 worker may have liability exposure that a W-2 worker may not have. You should discuss your situation with an attorney. If you’re going to be on a 1099, you should also discuss your possible insurance needs to protect you against any liability claims with an insurance agent who is knowledgeable about your field.
- Resume: which looks better on your resume? Employee with a title of XYZ company or Consultant to the XYZ company.
The intended takeaway from this article is that in most cases where there are few or no deductions to be taken by someone as a freelancer that it might be better to be a W-2 employee. They usually should be a W-2 employee which puts them right with the IRS. My own belief: when many employers want to pay a person who comes into their office to work as a 1099, this offer is made to save the employer money and not to benefit the employee. The employer may or may not know the rules that most of these working people should be W-2 employees.