W-2 vs. Self-Employed

By Bill Jackson October 6, 2023 5 mins read 132 Views

By Dr. Jim Dahle, WCI Founder

I am often asked whether it is better to take a job as an employee or accept a job as an independent contractor or some other version of being self-employed. The short answer is “it depends.” The best answer may be “both.” Let me explain.

Upsides of an Employee Job

There are a few significant benefits of an employee job.

Simplified Taxes

An employee is paid on a W-2 Form. Their taxes are relatively simple to file. Their employer pays the employer half of payroll taxes (Social Security on the first $160,000 of earnings [2023], and Medicare taxes on all earnings).

Employee Benefits

The employer may also offer some sweet benefits—like a 401(k) with or without a match, some portion of the premiums on health insurance, and maybe even some portion of the premiums on a group disability or life insurance policy. To the right family, these sorts of benefits can be very valuable.

Downsides of Being an Employee

There are two significant downsides to being an employee.

Unreimbursed Business Expenses

The first is that you can't deduct unreimbursed business expenses. Before the Tax Cut and Jobs Act of 2017, an employee could use Schedule A for those expenses, but they were subject to a floor of 2% of their income. For a physician earning $200,000 a year, that meant the first $4,000 of unreimbursed business expenses were not deductible at all. But now it's nearly impossible to deduct any unreimbursed business expenses. At least until 2026 when the Tax Cut and Jobs Act expires. That sucks.

Not So Sweet Benefits

The second downside is that you are stuck with whatever benefits (especially retirement plans) your employer sees fit to offer you. If the maximum contribution is low or if there is no match or if the expenses are high or if the investment options are bad, well, you're stuck with it. If your health insurance is crappy, you're welcome to go buy a plan on the open market, but if the employer is paying the premiums, it's usually a take-it-or-leave-it situation. It's the same with other employer-offered insurance.

More information here:

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Downsides of Self-Employment

More Complex Taxes

An independent contractor is paid on a 1099 Form. Their taxes are a bit more complex because they are both the employee and the employer. So, they must pay both halves of the payroll taxes, although the employer half is tax-deductible.

No Automatic Benefits

They also get no benefits except what they are willing to purchase for themselves. Since the employee is just one person, they get no benefits from an economy of scale when it comes to benefits (including malpractice insurance). If they want group disability or life insurance, they will need to get it from their specialty society.

Upsides of Being an Independent Contractor

Tax Deductions

Their work-related expenses are 100% deductible on Schedule C. Work-related expenses that go on Schedule C are far better than those that go on Schedule A because there is no floor. They also get to deduct their health insurance premiums, HSA contributions, and retirement plan contributions, which are all above-the-line deductions.

Choosing Your Own Benefits

Best of all, you get to choose your health insurance plan; your HSA; your 401(k); and, if desired, your personal defined benefit plan.

More information here:

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Which Job Should You Take?

If you find yourself comparing an employee job to an independent contractor job and you like both equally but are unsure which one pays more, it is best to try to do an apples to apples comparison.

First, take the employee job's salary and add to it the value of any benefits that you actually think are valuable.

Definitely consider any available

401(k) match,
HSA contributions,
Paid CME or vacation,
Any premium assistance on your insurance policies—such as malpractice, health, disability, and life.

Then, add in an amount equal to the non-deductible portion of the employer's half of your payroll taxes.

For Social Security, that is 6.2% × (1- your marginal tax rate) × $160,000.

For Medicare, that is 1.45% × (1- your marginal tax rate) × your entire salary + 0.9% × (1- your marginal tax rate) × (your salary – $200,000 or $250,000 if married).

Then, take what you would be paid as an independent contractor and subtract the value of the deduction on everything you could deduct that you could not deduct as an employee.

This might include the cost of

- Uniforms,
- CME expenses,
- Employer half of payroll taxes,
- Health insurance premiums,
- HSA contributions.

If the employer-offered retirement plan is crappy, you can also assign a dollar figure to the ability to choose your own.

Now, compare the two values. If one is dramatically superior to the other, you're done (or at least you can use that in ongoing negotiations). If not, then choose the job based on other factors.

As a general rule for a physician with an income near the median physician income in the $250,000 range, I would estimate that a typical independent contractor job ought to pay about 10% more to be equal to the typical employee job. But that rule of thumb is worth about what you paid for it since there is so much variation out there.

The Best of Both Worlds

Perhaps the best of both worlds is to get some of your income as an employee and some of your income as an independent contractor. That way you can write off all your work expenses that are required for your independent contractor job (but are used for both jobs—like CME, uniforms, licensing fees, DEA fees, specialty society dues, etc.) against your 1099 income. This way also lets you have your employer provide your benefits and at least the employer portion of the Social Security taxes, which are the lion's share of the payroll taxes for a doctor with a median physician income.

Another bonus of having two jobs is you may get two 401(k)s as well, allowing you to protect more of your hard-earned money from both Uncle Sam and any potential future creditors.

A Note on Partnerships

Many doctors, including me, are members of a partnership, which is often formed into an LLC and is paid on Schedule K-1/Form 1065. This has a lot of the benefits of being an independent contractor (lots of easily taken deductions) with a few of the benefits and downsides of being an employee. For example, you may get an economy of scale when negotiating benefits.

However, you are probably also subject to the rules of your partnership 401(k) and other retirement plans.

What do you think? Are you paid on a W-2, 1099, K-1, or all of the above? What do you like about it, and what don't you like about it? What would you recommend to other physicians? Comment below!

[This updated post was originally published in 2015.]

The post W-2 vs. Self-Employed appeared first on The White Coat Investor - Investing & Personal Finance for Doctors.

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By: The White Coat Investor
Title: W-2 vs. Self-Employed
Sourced From: www.whitecoatinvestor.com/w2-vs-self-employed/
Published Date: Fri, 06 Oct 2023 06:30:36 +0000