Many agencies and consulting firms will give you the option of being a 1099 contractor or W-2 hourly employee. The term “1099” refers to the tax form that clients send to their contractors at the end of each calendar year.

 

Even if you are already incorporated, there may be compelling reasons to choose working as a W-2 hourly employee over working as a 1099 contractor.

 

If you choose 1099, then you will submit periodic invoices with timesheets and expense reports and be paid as any other vendor would. Terms are typically 30 days.

 

If you choose W-2, then you will be paid from the company’s payroll system, typically once a week or once every two weeks. You will not need to submit an invoice.

 

I always try to get hired as a W-2 hourly employee, even though I have my own limited liability company. The rates for W-2 hourly employees are usually 10% to 15% less than for a 1099 contractor. The main reasons to choose W-2 are 1) as a W-2 hourly employee, your employer pays the employer portion of payroll taxes (7.65% of gross pay up to $102,000 for 2008), not you, 2) you will get paid faster, and probably won’t have collection problems, 3) your employer usually pays workers compensation insurance premiums, as well as premiums for liability and other types of insurance, on your behalf, and 4) if the agency files bankruptcy, employees have a higher priority of getting paid than contractors do.

 

On the other side, if you are an older worker (50+), you can contribute much larger amounts to a solo 401(k) plan as a 1099 contractor than you could as a W-2 employee.

 

Here are some factors to consider when deciding which option to choose:

 

• If you are a 1099 contractor, then you will be responsible for all of your own employer as well as employee payroll taxes;

• If you are an employee, then you will only be responsible for employee payroll taxes;

• If you are an employee and are laid off, you should be eligible for unemployment benefits;

• By choosing W-2, your net pay will probably be direct deposited into your checking account;

• Most agencies and consulting firms require proof of liability as well as errors and omissions (E&O) insurance from their contractors. Some even require proof of workers compensation insurance. If you are a W-2 employee, you probably will be covered under your employer’s insurance plans. Check with them to make sure;

• If you choose 1099, you can deduct operating expenses on your tax return, such as supplies and education expenses, in a way that will benefit you.

 

As you can see, there are many factors to consider.

 

Here are the federal payroll tax rates for 2008:

 

• Employer FICA: 6.2% up $102,000 (maximum $6324);

• Employer Medicare: 1.45% no limit;

• Employee FICA: same as employer;

• Employee Medicare: 1.45% no limit;

• Federal Unemployment Insurance: .62% of the first $7,000 in wages, or $43.

 

You will probably have to pay state unemployment taxes as well. In Colorado (where I live), it is about 3% of the first $10,000 of wages ($300), per employee.

 

All things being equal, you are typically better off being paid as a W-2 employee than as a 1099 contractor, as long as the rate is the same, or slightly lower. This is because the company that hires you will pay the employer portion of payroll taxes instead of you. They will also pay you quicker and deduct withholding taxes for you. They might even deposit your net pay into your checking account.

 

If you are incorporated, and paid as a 1099 contractor, here is what you need to do at the end of a calendar year (in mid-December), or quarterly during the year, to comply with government regulations:

 

• Estimate your net profit for the year (or quarter);

• Issue yourself a payroll check from your corporation, deducting all required taxes;

• Remit the taxes, including withholding, to the government, through your bank, by January 31 (or quarterly);

• Issue yourself a W-2 statement by January 31;

• File payroll tax returns with the government by January 31 (or quarterly).

 

I don’t mean to confuse you with all of this information. Deciding between 1099 and W-2 is something I have had to consider many times as an independent consultant. You should always consult with a certified public accountant or attorney if you have questions regarding the income tax, legal, and other aspects of this very important issue.

 

I look forward to reading your comments.

 

Mitch Paioff, Author, Getting Started as an Independent Computer Consultant