Thursday, February 23, 2012

Employment Models: 1099, W2 Hourly or Salaried, which is right for you? UPDATED for 2016


(This post has been updated in 2015)
An important question during most interviews in the HCIT industry is: Do you prefer W2 Hourly, 1099 or Salaried employment? Normally the candidate will understand the distinction between Salaried employment and W2 hourly or 1099 (Contract), but many questions arise during this part of the interview as the candidate tries to determine which scenario is best for them, particularly if it is someone that is new to consulting.

I won't delve much into salaried employment, which is pretty self-explanatory. Salaried employment or Permanent employment is when you accept an internal position with a company where you will earn a salary, receive full benefits and any other bonuses that company may offer. You can consider it like a marriage... you go into it, hoping it will last forever.

The 2 models I would like to dig into are W2 hourly and 1099 Contract and what the distinctions are between them. Consultants that have been in the industry for years normally prefer one to the other, but are typically open to either depending on the company they will be contracting for. Frequently when speaking to folks that are just venturing into the consulting arena, they express confusion over which option is best for them. Below is a simple break down that covers the basics.

W2 Hourly: In layman's terms W2 hourly is like short term employment. You receive an hourly rate for your work, you will often have the opportunity to opt into partial benefits, you will fill out necessary Tax Forms and the company will take out taxes prior to paying you. Your "employment" will last for the duration of the engagement that you have accepted. At the end of the engagement you will be free to accept another engagement from another company or if you're working for a company that is on their toes... they may have a new engagement to offer you and you can extend your time with them.

1099 Contract & Corp to Corp: The difference between 1099 and Corp to Corp is simple. In the case of 1099 you will use your social security number and be paid as an outside contractor by the company, this scenario is rarely practiced anymore. In the case of Corp to Corp you will have created a legal business for yourself (LLC or S-Corp etc) by registering through your state and you will sign a business agreement/contract between your company and the firm you are going accept the engagement through. Many firms are trending away from 1099 and Corp to Corp agreements. The reasoning behind this trend is related to the IRS cracking down on companies that utilize independent contractors when they deem the company should have brought the consultant on as a W2 hourly employee.** Typically the lines are blurred when discussing 1099 vs Corp to Corp because the term "1099" has become a catch-all phrase for both. As your own business entity you will be required to invoice the company you are contracting for. You will be paid an hourly rate for your services.

Which is best for you? Lets break them down:
Salaried / Permanent Employment
Benefits:
>Security - the security of internal employment within a company and the opportunity to advance within that company. 
>Full Benefits, bonuses, PTO, 401K etc
>Regular pay schedule
>Necessary equipment provided
>Company covers liability insurance
>Corporate Credit Card for travel when applicable (in most cases)
>Being on a consistent team
Potential Draw backs:
>Income is often less than what you can bring home as a W2 Hourly or Corp to Corp Contractor
>If working for a consulting firm or EMR vendor you don't always have the freedom to choose your engagements and must go where the company sends you.
>May have to relocate/no freedom to live where ever you want.

W2 Hourly
Benefits:
>Company deals with the taxes and covers liability insurance
>Option for benefits / PTO / 401K (in most cases)
>Equipment provided (in most cases)
>Regular pay schedule
>Regular travel reimbursement schedule or paid travel when travel is required
>Freedom to choose your engagements
>Potential for higher income vs Salaried employment
Potential Draw backs:
>Largely responsible for finding your own engagements
>Typically full benefits, bonuses, 401K and PTO are not included

1099 or Corp to Corp
Benefits:

>Full control of your business endeavors
>Higher income (in most cases) than Salaried or W2 Hourly consultants
>Freedom to choose your own engagements
Potential Draw backs:
>Must pay your own taxes on a quarterly basis*
>Must provide the company you are contracting for with invoices from your business
>Must maintain your own liability insurance
>Must provide your own benefits
>Often paid 30 days on invoice
>In some cases responsible for your own travel expenses (all inclusive rates)

*Always consult a CPA / Accountant when creating your own business to gain a full understanding of the tax laws and expectations.
** Tax Lawyers have explained that an old and somewhat obscure Federal Tax Law (#1706 from 1986) states that if the I.R.S. determines that a self-employed worker should have been an employee, it imposes substantial back taxes, penalties and interest on the hiring company AND on the contractor — even if the self-employed worker fully paid his/her taxes. For this reason many companies are shying away from using Corp to Corp (and 1099) contractors unless those contractors can prove that their business meets the federal criteria listed in the law. (employs at least 2 other people beside themselves and family members OR if they are in a partnership with someone other than family members OR they have incorporated (S Corp, C Corp etc) and file a 941 and pay yourself a salary) 

For more information on this law consult your local Tax Attorney.

As the IRS continues to crack down more and more, industry employers are moving away from 1099/C2C agreements and expecting the consultant work on a W2 hourly basis. Consultants that are flexible and open to W2 hourly contract work will increasingly have a better chance of placement as the industry trends in that direction. 
If you're a seasoned consultant and have comments about these options please post them!!

*Copyright - Expressed permission must be granted by the blog owner to recreate, copy or use this material* - but please feel free to share the link if you enjoyed the content!

25 comments:

  1. This is perfect timing for me to see this post. I am a new 1099 contractor and look forward any helpful guidance. Bring on the comments, seasoned contractors!

    ReplyDelete
  2. Thanks S&S! I hope we're able to get more input from the seasoned folks!

    ReplyDelete
  3. Hello! I've been an EMR consultant for more than 5 years and have worked under all 3 payment options listed here. You've offered some great clarity on these options, I'm sure this information will be helpful t up & coming consultants.

    One additional distainction I would make is that 1099 to an indiviidual is most often paid just like hourly (as far as timing; bi-weekly, weekly, whatever the clients normal pay period is) whereas corp-to-corp requires invoicing.

    I work corp-to-corp and the tax benefits can be great - provided you get an accountant and follow their advice! I have done 1099 as an individual and ended up with a tax bill because I hadn't paid quarterly taxes. It's so easy to put off paying those taxes but it will catch up with you :)

    ReplyDelete
  4. I'm finding that I pay quite a bit more taxes as a 1099 contractor than as a W2. The reason is that I give quite a bit of charitable contributions. As a W2 those contributions drastically reduce my personal tax liability. However, they do little to nothing to reduce my businesses tax liability.

    ReplyDelete
  5. Thank you for pointing out the misspellings! I fly through these and often don't use spell-check... I've made the necessary corrections!!

    ReplyDelete
  6. From Mary T. via email:
    I would rather be a salaried employee (consulting). I have been a 1099 and a contractor also but prefer the salary with benefits. You have ownership in the company that you represent.

    Thank you!
    Mary

    ReplyDelete
  7. via linkedin: From: Lesley Hughes
    Thank you, this article was very informative. I have been working as a consultant for about 2 years now and have only worked as W2 hourly. I have often thought about 1099 contracting and now I feel I have a better understanding of the pros and cons.

    ReplyDelete
  8. I am close to retirement and choose 1099 because of the opportunity to contribute a substantial amount into my pretax retirement 401k. My corporation matches at 25% of my salary which minimizes my wages subject to Social Security taxes and I also can control 100% the type of investments that are in my plan.

    ReplyDelete
  9. Hi Ronald, I am confused by your post because 1099 is a contractor however you mention a salary and 401K which an independent contractor would not receive from an "employer"

    ReplyDelete
  10. Hi,

    In your article that w-2 hourly consultant has less benefits than the w-2 salary employee. Except the PTO, will I get the health insurance or 401 K benefit just like the employee? If not then I will need to calculate that into my hourly rate, right?

    ReplyDelete
    Replies
    1. Hello Sun-Moon,
      Each company is different - some companies may provide PTO or specific benefits for W2 hourly consultants so it is important to ask during the interview process. The above blog/post is just an example. Thank you!

      Delete
    2. w2 consulting benefits are typically atrocious to the point where you should basically assume that you don't have benefits. For instance, it might cost you $175/week for health insurance for two people. And that's a high-deductible plan! Of the so-called "benefits-packages" I've seen from the big consulting companies, none of them have benefits that I would opt in to. It will typically be much cheaper for you to find your own health-insurance than use the contracting company benefits.

      Delete
    3. Also, great article! It clarifies a lot...

      Delete
    4. Thank you Nicholas! Great information. It is always best for a contractor to review the benefits and cost of benefits provided by the consulting firm and compare them to what they can obtain on their own!!

      Delete
  11. Via Linkedin -
    Donna Cusano • Thanks for this Cherie. It simplifies--accurately--the differences between employee, W2 hourly, 1099 and Corp-to-Corp arrangements, for those of us who aren't salaried anymore.

    ReplyDelete
  12. Thanks for giving the clear picture about those three concepts.

    ReplyDelete
  13. Via LinkedIn: I found your posting with regards to the subject above very helpful.

    Thank you very much for sharing it!

    Best regards,
    Petros Aidonis

    ReplyDelete
  14. Is there a formula for calculating a desired rate/hr. when shifting from a permanent, salaried W2 employee to C2C? Let's use the following scenario.

    a) A full-time employee is earning a base salary of 100k
    b) In addition to their base salary they also receive a 2.5% annual performance bonus, 25 days of PTO, 3% 401k employer match, as well as medical/dental and LTD.
    c) This person decides to become a consultant, establishes an LLC, and wishes to maintain a comparable income.

    I see three possible ways to calculate the desired rate/hr.
    1) Calculate the value of everything listed in b (above), add it to the $100k base salary and divide by 2080 (40 hrs/week x 52 weeks).
    2) Base salary + x%/2080
    3) Base salary/2080 + $x/hr

    Questions:
    1) Are any or all of these methods used?
    2) Are there industry standards or rules-of-thumb to determine the value of x in examples 2 & 3?
    3) Do you simply go by what the recruiting company tells you is the "going rate" for a given position?

    Thanks

    ReplyDelete
    Replies
    1. Hi Mary, I have a post on the blog about negotiating hourly rates. This should answer your questions. Thank you!

      Delete
  15. I am on a L2 EAD and have got an offer from a consultant for a project with a Bank. The model is that I get employed with the consultant who is contracting with another company who in turn has taken up a project with the Bank.
    My Employer - Intermediate Company - Bank.
    Bank pays the Intermediate Company - They pay my employer and He pays Me.

    My employer says that he will pay me a X$ per hour and give me a W2 every year and I do not have to pay any other income taxes. The X$ per hour in my account is my final income.

    Is this how W2 employment works OR do I have to separately pay taxes on the X$ per hour that I earn ?

    ReplyDelete
    Replies
    1. Hi Cynthia, my apologies, I am just now seeing your post. With W2 hourly you will fill out employment forms for the company that is paying you when you begin your employment then the company will pay taxes prior to paying you. At the beginning of the year they will send you your tax forms in order to file your taxes for the previous year. Its like salaried employment but you're only employed for the duration of the engagement. Hope that helps.

      Delete
  16. Via LinkedIn: Some additional - valuable information from Roger Walker RN, PMP

    “A significant factor that has been omitted from this discussion is the retirement investment aspect of each. As a w-2, you are eligible to participate in a company 401k after a period of time, often 6 mos to a year. During that period of ineligibility, a maximum dollar amount may be contributed to a traditional IRA( with $500 catch up if over 50). After eligibility is met, a maximum of $17,500 may be deferred in the 401k (403b in the nonprofit world) and there is sometimes an employer match of 3-6% often with vesting rules. As a 1099 (corp to corp in my case) I have a keogh plan that allows the $17500 of the 401k plus a profit sharing percentage determined when the plan is established. I deferred over $56K for 2015.... That's a fairly significant factor, in my opinion.”

    ReplyDelete
  17. is it mandatory to provide benefits to W2 hourly employees?

    ReplyDelete