1099 vs W2 – And the Winner Is?

by Kevin Mercadante

Are you trying to become an independent contractor? I can understand the attraction. They have more freedom and the potential to make more money. But there is a downside as well. In the battle between 1099 vs W2 there are distinct disadvantages for the “independent contractor” who would otherwise be classified as an employee.

Background

Millions of people are working in jobs where they’re being paid by 1099 rather than by W2. As employers face budget pressures, they’re finding creative ways to hire people for less money. The increasingly popular way to do this is to reclassify employees as self-employed contractors. By doing this, the employer eliminates a battery of expenses connected with employment.

While this could be the only way for an employee to get anything that looks like a job, it comes with a number of disadvantages that you should carefully consider before ever accepting such an arrangement.

No withholding of taxes by the employer

The most obvious disadvantage to working on a 1099 basis is when you have to file your income tax return, but no withholding has been done by your employer. If you have not made quarterly tax estimates, you will owe thousands of dollars every April.

What makes the arrangement worse is that the fact that no withholding can often mask a low rate of pay. Most of us are more concerned with “net pay” – the amount we take home and have available – than with gross income. But at tax filing time, the reality hits hard.

You have to pay FICA taxes – the self-employed version

Closely related to the missing withholding tax issue is the FICA tax. As an employee, you pay 7.65% of your income for Social Security and Medicare taxes. But as a 1099 employee, you’re considered to be self employed. That means you not only pay the 7.65% employee portion, but also the matching 7.65% employer portion. That’s a total of 15.3% of your income! Of course there are some distinct tax advantages of being self employed but this extra employment tax is a huge burden.

And remember that this is on top of the missing federal and state withholding taxes that you’ll have to come up with. From a tax standpoint, a 1099 arrangement is usually a win for the employer, but a certified disaster for the employee.

It can be argued that as a 1099 employee you can also deduct expenses that will reduce your income. But how many legitimate expenses will you have if you are working 40 hours per week at the employers office and under the employer’s supervision?** That alone makes it a questionable arrangement for the IRS, who could disallow the entire arrangement, including your expense deductions.

You have no benefits

One the most basic attractions of 1099 status from an employee standpoint is higher wages. An employer may pay more to a contract worker than to a regular staff employee. But this arrangement is not as genuine as it seems at first glance.

Employers can pay contractors more because they don’t pay benefits for the employee. This includes health insurance and paid time off and vacations. If you back the cost of typical employer paid benefits out of the hourly rate you get as a contractor, you may find that you’re actually being paid less than the salaried staff.

While it’s true that the higher pay rate will enable you to pay for your own benefits, you will generally pay more since you will carry them as an individual. Employer paid benefits are less expensive because they are paid though and for a group.

You’ll have no job security – ever!1099 vs w2

Most 1099 situations are pure “at will” arrangements. This means that either party can terminate the agreement on short notice and without further responsibility to the other. Employers like this arrangement because it removes obligations to the employee, and essentially reduces him to plug-and-play status. The employer can keep you for as long as they need you, then quickly discard you when they don’t.

If your 1099 arrangement is your primary source of income, a quick termination will be a precarious situation for you. You could lose your income on very short notice, and usually without warning, giving you little time to set up a replacement arrangement.

The arrangement is usually tailored to meet the employer’s needs

1099 work arrangements are usually set up primarily to benefit the employer. This is especially true if there is a written agreement, not the least of which because the contract has almost certainly been prepared by the employer’s attorney.

The agreement will be filled with provisions that mostly outline your obligations and responsibilities to the employer, while holding the employer responsible for very little. The employer will have the upper hand too. If you do not sign the agreement – or if you take issue with any of the individual provisions – you will not be hired. If you need the paycheck – maybe because your previous contract arrangement ended on short notice – you can either sign the agreement and start working, or they will find someone else.

Less legal recourse in the event of a dispute

As a contract employee you will have little, if any, of the protections that are normally afforded to workers under state and federal labor laws. The arrangement is considered casual at best, or that you are self-employed at the extreme (meaning zero protection for you).

And even if you were to take the employer to court, you generally can do little beyond suing for unpaid wages. The employer, on the other hand, can take legal action for a wide variety of issues, especially if they are neatly detailed in the contract that you signed.

Any written agreement between you as a contractor, and the employer are likely to specifically limit your ability to seek legal remedies, while protecting the widest range of legal actions for the employer.

A 1099 work arrangement, meaning the kind that attempts to position you as a self-employed contractor, can have you performing all of the responsibilities of an employee but with none of the benefits or security.

Have you ever encountered any of these problems when you were working on a 1099/contract basis?

 

A note from Neal: This is another well argued post by Kevin. He makes some excellent points and they are all important to consider. I believe that Kevin would agree with me that this boils down to your own personal situation. At the end of the day, a “bad” job is far better than no job.

** If your employer is playing games and you really don’t qualify as a contractor I suggest that you seek legal council before you accept the job. You might be stepping into some very hot water along with the boss.

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{ 1 comment… read it below or add one }

Troy June 21, 2013 at 6:40 AM

My brother is thinking of starting his own company, so i’ll definitely point him to this resource.

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