This is a very, very popular topic among doctors and it seems that everyone who comes along, puts their own little twist on it and convinces themselves that one is definitely better than the other.
Like most situations, there is no right answer, so I would say don’t spend your time looking for the objective, universal right answer, instead see how it relates to your exact situation.
In this post I will briefly touch up on the basics of this 1099 vs W2 debate and help you build some core knowledge which you can then apply to your own exact situation.
As you read try to keep in mind that the more meaningful discussion is about whether you are considered to be an independent contractor per the IRS or an employee.
Also, if you are getting benefits through work, have a “set” schedule, work full-time etc., then you are an employee, period. This post is more for those who have the option of being one or the other, or have options of different jobs that would classify them as one or the other.
How Are You Getting Paid?
Most of us are getting paid as a W2 employee when we’re doing our moonlighting/per diem gigs and even part-time or full-time gigs. The reason this happens is because large medical groups like to keep things simple, they prefer to minimize risks of lawsuits and they don’t want unhappy doctors.
The next popular way of getting paid is as a 1099 as an independent contractor, which is becoming more rare. Once we hit another economic downturn, look for the 1099 to make a comeback. Smaller groups tend to favor this, it saves them headaches on accounting and saves them money on payroll taxes.
Some doctors are also getting their income in form of partnership distributions, commonly a K1. This is neither a W2 nor a 1099. As a matter of fact, it’s not really a salary but a distribution of the profits of the business.
Finally, those of you who own your own businesses might have a combination of the above. You might be pocketing some of the cash that comes into the business, hiding it from the IRS, then you might be paying yourself some wages in form of a W2 and you might even give yourself some 1099 pay for any “consulting” work that you do for your own business, and finally you might send some of your K1 distributions either back into your business or into your pockets in form of a bonus.
Keep It Simple
Before I get into 1099’s and W2’s, let’s go back to the basics. When you create an S-Corp that pays you money one way and then files taxes on your behalf and pays you an income in another way, you are complicating your life, by a considerable margin.
True, there are real savings to be had here.
- You can form a LLC and file as an S-Corp.
- You can get a 1099 made out to Dr. Mo Inc. and pay Dr. Mo a salary out of that money and use the rest to pay for a commercial real estate property.
- You can use the 1099 to stash $54,000 into a Solo 401k.
The problem is, once you set up these kinds of complicated tax-sheltering systems, you also have to maintain them. And honestly, the doctors who set these up on their own, trying to skimp out on paying a lawyer to draw up proper documents, are often shooting themselves in the foot.
You need a CPA, a tax attorney and a business lawyer who can help establish, maintain and update such complicated systems. Not always, there are definitely those of us who are more savvy than the expert counterpart, but that’s not common.
Also, when you are using such systems simply to avoid paying taxes and protecting your assets, you may mistakenly mix your personal and business finances, which means that an astute lawyer coming after your ass, can easily pierce the corporate veil which you built up and get their hands on whatever it was that you were trying to protect in the first place.
What’s A 1099 vs W2?
When I was a resident, I used to get a W2 income from my residency and I would moonlight on the side, collecting income from various urgent cares who paid me a check for the hours I worked.
The main W2 income was great because I was a full-time employee, able to set $15,000 aside every year in a 401k along with some matching into a 457.
By the end of the year, often before tax-time, my per diems gigs would mail me a 1099-MISC form, which their accountant drew up, showing me as one of the expenses of a business.
They got my social security information, address etc. from a W9 form which I had to fill out through HR.
If I own an urgent care and hire a locum doctor to moonlight for me randomly, that person would be considered an independent contractor (also called a freelancer), not an employee. As such, I would pay them their flat hourly rate without subtracting any taxes.
So, a 1099 is simply a piece of paper which allows the IRS to follow a paper-trail, showing how much money left a company’s pocket and entered a doctor’s pocket.
If I worked 100 hours at $100/hour for the entire year for company-x, then I would get a 1099-MISC that shows $10,000 from them. Very simple. I would still owe taxes on this, since it’s considered an income. And I would likely have to make quarterly tax payments to the IRS before the traditional April tax-time.
From a 1099 income I would owe payroll taxes (FICA taxes, such as Medicare & SS), state income taxes as well as federal income taxes.
A 1099 can be made out to another business, to a person, to a sole proprietor, to an S-Corp, a LLC etc. If it’s made out to a business entity, such as Dr. Mo Inc., then my business would need a TIN (similar to a SSN) to enter into that W9 form, which I mentioned above.
What Is A W2 For Employees?
When you are hired on as an employee, you are given a W4 form to fill out, which helps you calculate how many allowances you can claim, allowing the company to deduct the appropriate taxes on your behalf.
The more allowances you claim, the lower your tax-rate. However, because we doctors are often subject to AMT (alternative minimum tax) and are phased out of many deductions, we end up owing taxes if we claim even the correct number of deductions.
A W2 is the form on which your paycheck is printed as an employee.
There is a ton of information on there, definitely worth understanding. As a funny side-note, talk to your HR specialist and 99% of the time they won’t know all the different items on your paystub – another reason to learn this stuff for yourself.
An employee’s W2 pay stub will have your federal tax withholdings, your state, medicare and social security withholdings as well as any retirement contributions. Local taxes show up on there as well.
You will find your health insurance, long-term disability (LTD) and HSA deductions on that form also.
1099 vs W2, Can You Choose?
This is the one question that keeps coming up. And it’s such a superficial question to ask. Before you can even delve into this, first answer the most obvious question, are you happy with your current job?
If you hate your job, then who cares, you probably should leave it. If all jobs in your field suck then, perhaps, you can contemplate looking for a job based on the potential tax-savings alone.
Next question to ask yourself, is the alternate job that pays the W2 or the 1099 better than whatever job you are trying to leave?
I know this seem like a silly answer, but you should never leave a decent job for another one because of the tax savings. I assure you that whatever taxes you can save on, you will lose those savings in another fashion just by doing something miserable.
Should you take on an extra 50 minutes of commute-time just so you can get a 1099 as an independent contractor? Probably not.
The Tax Advantages
Let’s get something cleared up, which drowns in the noise of the 1099 vs W2 discussion. Your ability to profit from the tax advantages of one vs the other has to do with your employment status. Namely, are you considered an employee by the IRS or an independent contractor?
If you are legitimately a freelancer, then it doesn’t matter whether you are getting a W2 or a 1099, you can still perform all the tax schemes which I’m about to outline below.
The caveat is, the IRS will consider you an employee if you are getting a W2 income and they will consider you a freelancer if you are getting a 1099 income – taking the steps to prove otherwise is on you.
The whole point of this argument is to save on taxes. By getting 1099 income paid to an S-corp, you can have some of the money paid to yourself as an employee of the S-corp and you can then shelter as much as $54,000 per year (as of 2017) into an individual 401k. This is accomplished by having the employee (yourself) set aside the max $18,000 for the calendar year, and have another $36,000 matched by your own corporation (the S-corp you established).
It’s not quite that simple but that’s the basic process. Consider that you have to keep track of the accounting portion yourself, unless you have a competent accountant.
Don’t forget about the IRS. You could be doing everything 100% correct, that doesn’t mean that you won’t get on the IRS’s radar. Dealing with the IRS is a massive drain on your soul, whether you’re in the right or wrong.
When you get a W2 income as a per diem physician, you likely aren’t receiving any benefits at all. There is no health insurance, no 401k, no profit-sharing, no cash balance plan, and no pension plan.
And if you are getting a W2 income, it’s assumed that you are an employee. Whether you are in fact an employee is a whole different topic. There is even a form on which you can contest the kind of income you receive. If you believe you should be getting a 1099 and not a W2, or vice versa, you can fill out form SS-8 and contest it. Should you get on the IRS radar, or your employer’s radar? I’m not sure.
How Much Can You Save?
If you are making $500k+ a year then it might make sense to fight for the correct designation of employee vs freelancer, or to switch from a W2 job to a 1099 gig.
If you are making in the $200k range, the math won’t make sense. In order to contribute that extra $36,000 on behalf of the corporation, you must have gross corporation income of at least $144,000 (25%).
I urge you to read up more on this, it’s definitely an interesting discussion, just working it out on paper or in your head can teach you a lot about taxes.
I recommend this book by Mark Kohler. It’s a great read for physicians and even more helpful if you are considering going the small-business route by starting your own practice.