Tag Archives: 1099 vs. W2 tax example

Tax Impact of being 1099 vs. a W2 Employee

So back in this post we reviewed how an employer goes about classifying a worker as either an employee or an independent contractor.  However, what if you are on the receiving end of that classification?  What is the financial and tax impact of receiving your pay either via W2 or 1099?  In this post will follow the exploits of two workers, Suzy Salary and Contractor Chuck.  To keep this example simple and straightforward, we’ll assume the following about both Suzy and Chuck:

  • Work similar jobs (with different companies)
  • Don’t have any pretax contributions coming out of their checks
  • Each  make $100,000 per year
  • Are both single without any dependents and take the standard deduction
  • Didn’t have any Federal income taxes withheld from their checks (i.e. Suzy didn’t have these deducted from her check, but we’ll assume Social Security and Medicare were withheld)
  • IRS penalties don’t apply
  • We’ll ignore the whole 2% payroll holiday that has been in effect the past few years

Amount Earned The easiest difference to spot will be in the amount of their checks.  Suzy will take home about $93,800 (due to combined 7.65% withholding of Social Security and Medicare) while Chuck will take home the full $100,000.  However, it gets interesting when the two actually go to file their tax returns.

Self Employment Taxes The basic concept to remember with this is that when you work for someone, you and they split the Social Security and Medicare taxes equally (i.e. 7.65% for each of you).  However, when you are self employed, you have to foot the whole bill or 13.3% up to income of $106,800.  True you will see an adjustment on the 1st page of your tax return (it’s labeled “Deductible part of self-employment tax”), however due to the nature of the calculations, it doesn’t yield you a true 50% benefit.

Bottom Line Tax Impact  At the end of it all, Suzy will wind up paying about $18,957 in income taxes and $6,200 in Social Security and Medicare for a total of $25,157.  Chuck on the other hand will pay $16,979 in income taxes and $12,283 in self employment for a total of $29,262.  Total tax bill difference winds up costing about $4,105.

Why Bother Being 1099?  If your employer gives you the option between the two, the W2 option will more than likely put you at ease.  You won’t have to worry about setting cash aside for your taxes bills as your boss will simply withhold them.  However, the truth of the matter is that most individuals who are “truly” considered contractors actually may pay a lower tax bill due to having expenses associated with earning their income.  For example, a cable installer will typically have the cost of keeping up their vehicle, supplies necessary to perform the work as well possible office related expenses.  In the end, they can deduct these allowable expenses on their return whereas an employee cannot.

So if faced with a choice of which type of way you would like to be paid, take the time to consult with your tax practitioner as they can advise you on the possible ramifications of your particular situation.