I'm considering doing some consulting for a company, and I think the normal way contractors are paid is with checks made out directly to them, with no taxes withheld. In other words, it's up to the contractor to file his taxes quarterly with the IRS.

It seems like it'd be a lot easier for the contractor if they had a W2 with the company and the company withheld their taxes for them. The company would already have, presumably, have the infrastructure to process W2's, so in some ways, it doesn't seem like it'd be a huge burden on them.

I guess the flip side would be this: What other expenses would the company incur if they were to deduct your taxes for you with a W2? Would you actually count as a full on employee at that point? Would they have to still offer you health insurance?

How much of a burden it'd be for a company to do that and how can I determine my employment status?

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    A W2 would mean that you were an employee of the company not a contractor. That would mean that the company would need to give you whatever benefits an employee would be entitled to (health insurance, 401(k), etc.) – Justin Cave Aug 14 '14 at 19:41
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    What I have seen is that you're called a contractor, but you're an employee of a contracting firm that pays you W2, kind of crap health insurance, and may also offer some sort of IRA or 401(k) – Amy Blankenship Aug 14 '14 at 20:23

Whether you're a 1099 contractor (what you initially describe) or a W2 employee is as much a matter of fact as a matter of what's easier or cheaper.

At least in theory, a contractor should be someone who is largely in control of things like schedules, you often provide your own tools, etc.; you are performing a specific service for the company, but how you perform that service is up to you (within obvious limitations, such as budget and project deadlines). You may work for many companies at once.

An employee is someone who is expected in the office at certain times, is expected to follow corporate procedures, may be told how to do their job in addition to what the end results should be, and uses tools provided by the company. You probably only work for one company.

While in some cases you may have the opportunity to be either one, much of the time only one of those descriptions fits. Think of a plumber: if you are called to the work site at need, and tell them when you can arrive, if you bring your own plumbing tools, and if you can reject work when you're too busy, then you're a contractor. If you are working at the company 9-5, are told when to be where, and use the company's tools, then you're an employee.

They don't necessarily have to offer you all of the same perks as a full employee - that's up to the company to determine how you qualify for their benefits, but especially post-ACA you likely would have to be offered health insurance at a minimum unless it's a very small company. Some benefits (like Workers Comp eligibility) accrue automatically as part of being an employee.

As far as the company goes, there are significant additional taxes required for a W-2 employee, both for the employee and the company. Medicare, Social Security, Unemployment, and Worker's Comp insurance are all needed for a W-2 employee from the company; for a 1099, you pay Medicare/Social Security yourself (and pay a higher portion, as the employer usually pays a part of that) under Self Employment taxes, if you made more than $400. Companies would certainly prefer you to take 1099 status, to the point that billions of dollars per year in penalties and back taxes end up owing due to misclassification of workers as 1099 when they shouldn't be.

See the IRS's tip sheet on determining employment status for more information.

  • Related to Amy's comment on the question, for this answer I'm assuming you are directly employed/contracted from the main company. This doesn't apply if you're contracted from an agency who employs you (in which case they pay you as a W-2 employee). – Joe Aug 14 '14 at 20:57

See the previous answer that summarized the legal difference between a contractor and an employee. If you are classified as a contractor by the IRS, you have some advantages as well, and not just the burden of paying twice as much Medicare and Social security taxes.

If considered a contractor by the IRS, you have your own business. You can deduct your business expenses such as tools that you bought for work use, car expenses(only the % of them used for miles driven for work purposes), cell phone line you are using for work and even the interest and depreciation of a part of your house you are using as an in house office assuming this room is purely an office. So to summarize you will pay higher taxes but only on the taxable income which will be after you deduct all your qualifying business expenses.

You should ask a tax adviser regarding details on what else and how much is allowable deductible expenses.

Hope that helped.

  • this post is rather hard to read (wall of text). Would you mind editing it into a better shape? – gnat Aug 16 '14 at 0:27

As a general rule, a person paid under a W2 is an employee; a person paid under a 1099 is an independent contractor. As in all things legal, it depends on the details.

The financial impact is fairly straightforward

The easiest answer is that a 1099 worker must pay the self employment tax to the Federal government out of his gross wage.

The W2 employee does not pay that tax. The employer pays an equivalent amount in addition to that which has been withheld from the paycheck.

The W2 employer also must pay into the state Unemployment Insurance Fund. The 1099 worker does not have such payment made on his own behalf. That impacts the employee when he is laid off and applies for unemployment benefits. He may be denied benefits because there were no deposits made in the base period.

Occasionally an employer may claim that a 1099 person is an independent contractor for workers' compensation purposes. If that is upheld the employer's premium is lower but the 1099 person is not covered if he has an on the job accident.

Because the workers compensation aspect has such a large financial impact on the employee and because there is so much financial incentive for an employer to characterize someone as an independent contractor, many states have passed statutes specifying precisely who can be paid like an independent contractor,i.e., under a 1099. There are substantial penalties for an employer who tries to manipulate the system.

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