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As a W2 worker for a US company, my monthly pay was divided into 3 quantities: $X in salary, $Y in per diem, and $Z in car allowance. The benefit was that I would only pay tax on the salary, so my monthly pay is $X + $Y + $Z, but I would only pay income tax for $X.

If I change to a 1099, can the employer divide my pay into 3 different quantities, similar to a W2?

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There would be no point in them doing that. If you change to a 1099, you decide what deductions you have, not your employer. Them calling some payment a "per diem" or a "car allowance" would have no effect on the amount of income you can claim as a deduction for business-related expenses.

To use a simple example, consider if you hire an electrician to do some work as a 1099 contractor. You'll pay them for parts and labor. They may have fees they charge you for transportation or other things. All of that goes into one big bucket -- money they got from you.

When they file their taxes, they report how much money they got from you. That's their gross income. Then they deduct their business expenses. If they bought materials for the job, the actual amount they paid is a deduction. If they traveled, they can deduct travel expenses or mileage. If the electrician has a home office, he may be eligible for a home office deduction, and so on.

The electrician will, we hope, have some profit left from the amount you paid him after he takes all his deductions. He'll pay taxes on that -- including the employer's share because he's the employer too. It makes no difference if you pay him $1,000 for labor and $200 for materials. He got $1,200 either way and his actual cost of materials is deductible either way.

Assuming your job control and responsibilities are the same either way, the main advantages of being a contractor are that you get paid more and have access to more tax deductions that you may qualify for. The main disadvantages are that you typically wind up paying more in taxes, your taxes are much more complicated, your tax audit risk is higher, you don't get any benefits like health insurance or a 401(k), you aren't eligible for unemployment insurance or compensation if you're injured on the job, it's harder to get a mortgage, and probably quite a few others I'm forgetting. At least you can't be fired.

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  • I assume that if my salary ($X) is half of the total ($X+$Y+$Z) then the income tax is much less than paying income tax for $X+$Y+$Z. Also, I don't have many deductions. – Ralph Enderson Dec 19 '18 at 19:34
  • As an engineer working onsite, I don't have many deductions. So I assumed that paying income tax for half my monthly payment would benefit me. – Ralph Enderson Dec 19 '18 at 19:37
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    @RalphEnderson If you don't have many deductions, you will take a huge tax hit by being a contractor. You'll have to pay the employer's share of taxes (since you are the employer now) and you will only be able to deduct actual, deductible expenses. 1099 contractors don't get a salary from anyone but themselves. (See updates.) – David Schwartz Dec 19 '18 at 19:55
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OK, the first thing you need to know is that you're talking about being a contract employee, and not a contractor.

A contract employee would be subject to the policies in place by the employer. There is no "law" about what is and is not permitted for payments. However, you will need to report all payments appropriately and report all expenses appropriately. In the US, that would end up on schedules C and SE, respectively.

If you were a contractor, then you would be your own entity doing jobs or providing services to the company, and their policies would not matter, as it would be your policies that come into play.

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  • Minor nit: A contract employee is a type of contractor. This is why all the legal rules for contractors apply to contract employees. – David Schwartz Dec 19 '18 at 21:51
  • @DavidSchwartz - I know a lot of people see it that way. I am not among them. – Wesley Long Dec 19 '18 at 21:52
  • Oh, then it's major nit because that's an actively harmful claim to make. For example, if you don't understand that contract employees are contractors, you will misunderstand a lot of IRS guidance. Such as this and this where nothing said about employees applies to contract employees but everything said about contractors does. – David Schwartz Dec 19 '18 at 21:57
  • @DavidSchwartz - Then I'll be your nit. I understand this extremely thoroughly, as I've been both on multiple occasions. I know the difference quite well. – Wesley Long Dec 19 '18 at 21:59
  • Then downvoted because you are knowingly and affirmatively misleading people into misunderstanding many things that others have written because of a quirky, personal view that you are not identifying as such but instead stating as if it was the majority view. – David Schwartz Dec 19 '18 at 22:00

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