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Consultants: W-2, 1099 or Corp-to-Corp?

Do a quick search on Google and you'll find thousands of pages with people trying to figure out how to answer this question: I have a new consulting gig, should I go W-2, 1099, Corp-to-Corp? This seems to be the $64,000 question for consultants and independent contractors. So what is the answer? I've laid out the answer in three ways:

Each will provide more detail than the previous. I'll also provide example scenarios so you can see the financial impact of each type of business organization.

Caveat: I've tried to be as complete as possible. However, for the sake of clarity I've had to make some pretty broad simplifications. This document tries to present the basic issues you should consider in a balanced way. Remember information is not advice. Consult with your own accountant or tax professional if you want professional assurances about the information presented here, and your interpretation of it, is appropriate to your particular situation.


The Really Short Answer

Be sure to consider you own personality, however, nine times out of ten it is financially more beneficial to go Corp-to-Corp, provided you:

  • organize as an S-Corp and you make all the tax filings and deposits on time.
  • hire some help to handle all the taxes and other administrivia.

Most people will find handling the payroll, taxes and filings overwhelming. You will probably spend less on the help than you would on interest and penalties if things go awry.

The Short Answer

The biggest factor that should impact your decision is your own personality. The three options (W-2, 1099, and Corp-to-Corp) vary in complexity with W-2 being the simplest and setting up your own corporation the most complicated. You need to weigh the trade-offs of each approach and pick the one that fits your lifestyle best. Because in the end the money you save on taxes won't seem worth it when you start pull out your hair, or what's left of it. :)

Based on your personality, here are the three options:

Are you a procrastinater? Consider W-2

If you're the kind of person that absolutely hates tax time, procrastinates until 10pm on April 15th, and would rather get a root canal than fill out a government form, you should consider W-2. You may not find the extra tax savings worth the headaches.

Are you detailed-oriented? Consider Corp-to-Corp

On the other hand, if you balance your check and credit card statements to the penny every month, you always get your tax returns in early or, ideally, have some accounting background, setting up and maintaining your corporation may not be that big a deal.

Do you like to challenge authority? Choose 1099 at your own risk

If you're not easily intimidated and the idea of taking on the IRS gets your juices flowing in a good way, you might consider the 1099 (AKA self-employed) option. But there are some downsides to being self-employed that will probably lead you to choose one of the other two options: like your return is more likely to catch the eye of the IRS than any of the others discussed here.

The other option: Regular Salaried Employee

Remember to consider being a regular employee instead of a consultant. You will probably pay more in taxes but you will get substantially better benefits. With 46 million uninsured Americans and abysmal savings rates, the advantages of the benefit packages offered by most employers should not be ignored.

The Long Answer

Now we're going to get in to the nitty-gritty details. I've broken this section down further and we'll discuss the issues you'll face for each of our three options.

Remember to take a look at the comparisons to see how the specific details impact the trade-offs you have to make in coming to your decision.

First things first: Are you really an independent contractor and why does this matter?

Employees are entitled to certain legal standing and benefits that are not available to independent contractors. In addition, employers are required to pay certain taxes on employee wages. The distinction of independent contractor or employee may not matter to you now, but it will likely matter very much to your client and the IRS. It may also matter to you later if the IRS later rules that you were an employee and disallows your independent contractor status. Your client will probably make decisions based on this distinction and it behooves you to understand the distinction to avoid getting stuck between your client and the IRS later.

The general rule is that an individual is an independent contractor if the organization for which the services are performed has the right to control or direct only the result of the work, and not what will be done and how it will be done or method of accomplishing the result. However, whether an individual is an employee or independent contractor depends on the facts in each case.

As listed in IRS Publication 1779: Independent Contractor or Employee?, the courts have determined there are three categories of facts that are relevant in determining your work status:

  • Behavioral Control: These facts show whether there is a right by the business to direct or control how the work is to be done. A worker is an employee when the business has the right to direct and control the worker. The business does not have to actually direct or control the way the work is done as long as it has the right to direct and control the work.
  • Financial Control: These facts show whether there is a right to direct the business part of the work. For example if you have a significant investment in your work and your expenses are not reimbursed, you may be an independent contractor. If you can realize a profit or incur a loss you may be an independent contractor.
  • Relationship of the Parties: These facts relate to how the parties view their relationship. These include things like benefits such as insurance, PTO, etc. If you have these, this is an indication you're an employee. A written contract may show what the parties intend if it the relationship is otherwise unclear.

There is also more detailed information in Chapter 2 of IRS Publication 15-A Employer’s Supplemental Tax Guide.

OK, so let's say you are indeed an independent contractor. Now we get back to the main question: W-2, 1099 or Corp-to-Corp?

W-2 Employee

Definition:

You are an employee of the broker selected by your client. Your wages are subject to the same tax withholdings as a regular employee.

W-2 Pros:

  • Easiest and simplest option.
  • No bookkeeping needed other than submitting time sheets.
  • Some limited benefits may be available.

W-2 Cons:

  • Limited ability to defer income if a 401(k) benefit plan is unavailable.
  • Deductibility of unreimbursed business expenses and medical insurance premiums are very limited.
  • Getting health insurance coverage if none is provided can be a challenge.
  • Any benefit package is likely to be less generous than if you were a regular employee of the client.

The Simplest Option: W-2

You are basically an employee of the third-party broker hired by your client, although any benefits package offered is likely to significantly less than if you were a regular employee of the client company.

Usually the client has a head hunter, broker or other third-party service that will act as the intermediary between you and them. Your client may prefer this option because it mitigates the risk that you or IRS will come to them later and claim you were really an employee.You will receive wages from the broker with the requisites taxes withheld. The broker will probably receive 15-35% above your hourly rate to cover its expenses. Something to keep in mind when you're negotiating your rate.

Benefits? Maybe.

Some brokers will provide you with medical and dental insurance options, life insurance, Section 125 flexible spending and even a 401(k) plans. The costs of these benefits to you are much higher than if you were a regular employee of the client. If there's no 401(k) plan, your only retirement plan option is either a traditional or Roth IRA.

Any Way to Reduce Your Taxes? Few, If Any.

Your ability to deduct unreimbursed business expenses is only available on amounts over 2% of your Adjusted Gross Income (AGI). Medical expense deduction, including premiums, is limited to amounts over 7.5% of AGI. (Note: any premiums paid with pre-tax dollars are not eligible for the deduction.) You may be able to defer some income by contributing to a traditional IRA that can help reduce your AGI.

1099 Self-Employed Sole Proprietor

Definition:

A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain. The business has no existence apart from you, the owner. Its liabilities are your personal liabilities. You undertake the risks of the business for all assets owned, whether used in the business or personally owned. You include the income and expenses of the business on Schedule C of your own tax return.

1099 Pros:

  • Easy to get started.
  • Easy to discontinue when your contract ends.
  • Losses might be used to offset other income (limits apply).
  • Small business retirement plans offer the opportunity to defer more current income than traditional IRAs.
  • You might be eligible to take the Home Office Deduction.

1099 Cons:

  • Unlimited liability for the owner.
  • All profit is subject to self-employment tax in addition to the income tax.
  • More administration and bookkeeping than W-2 option.
  • You must make quarterly estimated tax payments.

Most companies are wary of going 1099 to an individual. The IRS can review your situation after the fact and decide you were really an employee and nab the company for back payroll taxes and massive penalties. Therefore, to limit their exposure, most companies prefer either W-2 or Corp-to-Corp relationships.

Starting Your Self-Employed Business

If you manage to make this arrangement with your client you don't need to do anything special to get started, at least as far as the IRS is concerned. Your state, county or city may required you to get a business license or make a Fictitious Name or DBA (Doing Business As) Statement. You'll need to check with your local governmental agencies to find the requirements in your area. You may also need to check for zoning restrictions. Check out the IRS Small Business Website for more information than you could possibly consume. A good place to start is the recommended reading list, especially Tax Guide for Small Business.

One advantage is you can start right away; you can deposit you checks right into your personal checking account. Although, if you can find a no fee checking account it will make your bookkeeping a lot easier if you have a separate bank account for your business and pay all your expenses from this account. You can keep track of your books in something simple like Quicken or MS-Money.

Filing Your Income Taxes

As far as taxes go, you should receive a 1099-MISC from your client indicating the payments made to you for the calendar year. This is what people are talking about they talk about "going 1099". What they really saying is you're a self-employed sole proprietor and the client is required by IRS regulations to report the amounts they pay you on Form 1099-MISC. They report this amount both to you and the IRS. You report the
income and deduct expenses that are directly related to the business on Schedule C. The net income from your business will flow through to your 1040, line 12 and you will pay tax on the net income at your personal marginal tax rate.

Income

The IRS will match the total income you report on your Schedule C to the total of all 1099s you receive. If you under report income the IRS will come knocking looking for a good explanation.

Expenses

As a contractor, expenses usually don't amount to much compared to the income most professionals receive. Any expenses incurred to purchase books, subscriptions, professional organization dues, education for maintaining and improving your skills, etc. are all deductible. If have a second phone line dedicated to business use, you deduct all expenses for that line. However, if you have only one land line in to your home, you can only deduct the charges for specific calls you can identify as business-related. Your client may require you to get business liability insurance and those premiums are deductible. If you hire a bookkeeper, payments to that person are deductible, too. As are any amounts you pay to have the Schedule C, SE and related tax forms prepared as part of your personal return. See IRS Publication 535, Business Expenses for all the details on what's deductible and what's not.

If you have to purchase equipment look into the Section 179 election which allows you to expense in the current year amounts paid for new equipment used in business. There are some limitations but it's usually worth doing if you can. See IRS Publication 946, How To Depreciate Property, Chapter 2, Electing the Section 179 Deduction for more information.

The Home Office Deduction

It seems like everyone who starts a business wants to take the home office deduction. There are some definite gotchas to watch out for with the home office deduction. The biggest one is the IRS itself. Deducting your home office can increase your chances of an audit. Additionally, if you elect to depreciate your home office, you may incur additional taxes when you sell your home. Take a look at IRS Publication 587, Business Use of Your Home for all the hairy details of the Home Office Deduction. Note these rules apply to all three options, W-2, 1099 and Corp-to-Corp.

The hairiest detail of them all is if you qualify. The standard test is: You must use part of your home exclusively and regularly as your principal place of business. "Exclusively" means just that! If you use the same space to pay your personal bills, call your mom to wish her happy birthday, or it doubles as a guest room... You've just blown the qualifier and you can't take the deduction.

Is the Home Office Deduction worth it?

First, you have more forms to fill out:

  • Form 8829, the form to list the home office expenses
  • Form 4562, if you depreciate the business portion of your house.

The major expenses of your home are likely to be the mortgage interest and the property tax. You can only deduct this once, so you need to allocate the portion of these expenses that apply to the personal and business portions of the house. The personal part goes on your Schedule A as part of your itemized deductions; the business part goes on Form 8829. (The allocation is usually done on a square footage basis.) So unless your itemized deductions are being limited, you don't get any additional tax benefit because you can deduct these on your Schedule A anyway.

The other things you can deduct, like insurance, utilities you have to allocated between personal and business too. So say you spent $1400 on home owners insurance and $3000 on utilities (excluding telephone) and your business use of the home is 10%. That gives you a deduction of $440. If you're in the 25% tax rate, that's a total tax savings of $110.

This is where your personality comes into play. Personally, the $110 isn't enough for me to risk the red flag this may raised when the IRS is looking for returns to audit.

Depreciating Your Home Office

Now we come to the depreciation part. I'm not going to do a disertation here on what depreciation is but suffice it to say that you are allowed to expense in the current year the portion of your home used for business purposes. You have to depreciate the home over a 39 year period. Here's a simplified version of the thrilling formula used to calculate the depreciation expense:

[(basis of your home - land value at purchase) X business use %] / 39 years.

Say you started your business on January 1st to simplify the calculation. You purchased your home for $250,000 and land value was $75,000 and your business use percentage is 10%. You're looking at $449 annual depreciation expense. [($250,000 - $75,000) * 10% / 39] Again, if you're in the 25% tax bracket that equates to $112 in income tax saving. I'll grant, that's per year, but even with the $110 from the example above $222 isn't enough for me to tempt fate, or the IRS at any rate. Again the calculation goes back to your personality and risk aversion.

OK, Say you decide to go ahead and depreciate your home office for 10 years, you've depreciated $4490 of the value of the house. Now you decide you want to sell it. That $4490 is not eligible for the $250,000 exclusion on the sale of your primary residence and you must pay taxes on that amount when you sell the house. So unless you plan to live in your home until you die, the home office depreciation deduction is really a deferral of taxes.

If you're really up on being self-employed, you'll know that any deduction will also save on self-employment taxes. We'll cover this in a later section. The $889 home office deduction in the example above ($440 for insurance & utilities and $449 for depreciation) will also save you about another $127 in self-employment tax. Now we're up to a total tax savings of $349 in the current year. Again you need to take your own personality into account to determine if the tax savings (or deferrals) are worth it to you.

Pay Yourself First and Reduce Your Taxes: Retirement Saving Plans

There are several ways to defer taxes on current income that have strings attached. The most popular are the retirement savings plans. By saving money in a Retirement Savings Plan now, like a SEP-IRA or Individual 401(k), you can reduce your taxable income in the current year.

Congress has been adding to and changing the rules on existing retirement plans trying to increase the US savings rate. The good news is you can get more bang for your buck as self employed than you can as a regular employee when it comes to getting your retirement savings to reduce your current year's income taxes. To get more information see IRS Publication 560, Retirement Plans for Small Businesses.

Briefly, options are the traditional and Roth IRAs, SEP-IRA, Qualified Plans, and the new Individual 401(k). For example, the maximum contribution for the Individual 401(k) is $44,000 in 2006 (subject to income limitations). That will go along way to reducing your tax liability. Be sure to check the requirements deadlines for setting up and funding the plan and the limitations on withdrawals before you get started. Usually any withdrawal prior to the year you turn 59&½ are subject to a 10% penalty. Each plan has different rules for exceptions to the 10% penalty rule.

Self-Employment Taxes: The Unexpected Tax

This is where the self-employed really lose out over corporations. Any profit on earned income that accumulates in your business is subject to self-employment taxes. This is true of partnerships and LLCs, too. Only corporations are not subject to this tax on accumulated earnings. They have their own tax on excess accumulations to worry about, but it usually doesn't affect small corporations.

Before we get too far, just what are self-employment taxes? Self-employment (SE) tax is a social security and Medicare tax primarily for individuals who work for themselves. It is similar to the social security and Medicare taxes withheld from the pay of most wage earners.

You may not be aware that your employer matches every dollar that is withheld from your W-2 paycheck for social security and Medicare taxes. Employees pay 6.2% and employers pay 6.2% for a total of 12.4% on the first $94,200 of wages (that's the social security cap for 2006) and 1.65% each for a combined total of 2.9% on the remaining amount for Medicare. As a self-employed individual, you get to pay both halves, but the IRS gives you a bit of break and you can exclude the first 7.65% earned income. Plus you get another "break" because you can deduct half of your SE tax from your taxable income (Form 1040, Line 27).

So many people go into business with no idea this tax is out there then come April they get slammed with the SE tax. Then the IRS will get them for interest and penalties because they didn't make any payments toward it throughout the year. It can be quite a shock!

Pay As You Go: Making Quarterly Esitmated Tax Payments

Our tax system is a "pay as you go" system. That's why taxes are withheld from your regular paycheck and the self-employed (and others) have to make estimated payments. Estimated taxes are used to pay taxes (including SE tax) on income not subject to withholding.

You generally have to make estimated tax payments if you expect to owe taxes, including self-employment tax, of $1,000 or more when you file your return to avoid an underpayment penalty.

The tricky part is you have to make your quarterly payments even though you may not know exactly what your income, and therefore your taxes, will be. That's why they're called estimated taxes, but still it's a source of stress and confusion for many.

Estimated tax payments are due on April 15th, June 15th, September 15th and January 15th.

Other things to keep in mind

Fringe Benefits

As a self-employed individual, you will receive no benefits. This can be a lot more important for families than individuals. With the cost of health insurance rising for everyone, this benefit alone is enough for some people to prefer regular employment with full benefits.

If you had insurance with a previous employer, look into continuing coverage with a COBRA plan. Failing that, you should be able to get an individual policy under the HIPAA laws, that's the health insurance portability legislation that went into affect several years ago. It can help you get at least some kind of insurance.

For the self-employed health insurance premiums are deducted on the front of your 1040. That's good news because you aren't subject to the 7.5% AGI limit for itemized medical deductions. But it's bad news too because these expenses don't reduce your SE taxes.

Financing

If you're planning on a major purchase you may have more difficulty qualifying for a loan. Banks like to see the regular income of a W-2 or pay stub. If you want to get a home loan you'll probably have to provide the two previous year's tax returns, financial statements, letters regarding the state of your business, etc.

It's generally takes little longer to get a loan and you may not get as good an interest rate. It is possible to get a loan, all things being equal, but it can be a pain and a bit stressful. (This can apply to all small business owners regardless of how their business is organized.)

Corp-to-Corp

Definition:

Corp-to-Corp means that your client, a corporation, pays your business, which is organized as a corportation, for the services rendered by you. Your client may prefer this as it protects them from the same risks regarding the employer-employee relationship discussed in the W-2 option above.

Pros & Cons apply to S-Corps: only an S-Corp can avoid the 35% Personal Services Corporation (PSC) flat tax.

Corp-to-Corp Pros:

  • No self-employment tax.
  • Using small business retirement plans, you can defer tax on a larger percentage of income.
  • Double taxation of earnings is avoided as compared to regular corporations.

Corp-to-Corp Cons:

  • Most complicated option. Much more bookkeeping and tax reporting required.
  • More difficult to organize and dissolve.
  • Some states have a minimum tax you will have pay regardless of profitability.
  • You must receive at least some salary from the corporation, which means the corporation is subject to payroll taxes and filing.
  • S-Corp shareholders pay tax on undistributed profits.
  • If you don't make the S-Corp election you can get stuck with the 35% Personal Services Corporation (PSC) flat tax.

The biggest draw back of setting up your own corporation is the extra time, yours or someone else's, required to set up and maintain the records of your corporation and all the required tax filings. If you like this kind of stuff, it's not a big deal. If you hate doing this kind of stuff you should probably hire someone else to do it for you. Or reconsider the W-2 option above.

Incorporating your Business

First a caveat. When you incorporate it has to be in a particular state. Every state has different rules so you should check with the Secretary of State, Department of Corporations, or other equivalent governmental agency in your state. Each state has different rules and tax regulations. For instance, if you are doing business in California, you must pay and file taxes in California, even if you are incorporated in another state. California has an $800 minimum tax requirements so your corporation will end up paying taxes each year it does business in California regardless of its profitability. You need to find out the rules in your state before incorporating your business.

There are several services that will do all the paperwork of incorporating your business. There are also several software programs that will walk you through the process. It isn't too difficult but it is a little time consuming. Remember each state is different.

Separate Entities: You Are Not Your Corporation

Once you incorporate, you and your business are two entirely different and separate legal entities. This protect you from personal responsibility for liabilities incurred by the corporation.

You should treat transactions between you and your corporation the same as you would any other business. You wouldn't go pulling the money out of another business' cash drawer, so don't do that with your company. At least not without proper documentation and record keeping.

Record Keeping

As a corporation you will not receive a lot of the tax documents you do as an individual. You won't receive a 1099 from your client. You have to keep track of all this. You will need to invoice your client on a periodic basis. Make sure they are paying you in a timely manner. As a corporation, be prepared to wait 45-60 days to receive payment on your invoices, especially the first one.

You will have to get a separate checking account for your business. Your bank will not let you deposit checks to your business into your personal account.

The IRS requires you to keep written records of your business. Make sure you keep receipts associate with each payment. Avoid making checks to "Cash" or paying non-business expenses form your business checking account.

If you personally pay for valid business expenses. Reimburse yourself, just as if you were requesting a reimbursement from an employer, providing valid receipts for each item being reimbursed.

So if you can't just take money when ever you want, how do you get money out of your corporation? The business writes you a paycheck!

Payroll: Things are starting to get a little complicated....

If you incorporate your business, you are an employee of the corporation and you will need to pay yourself a salary. This is true even if you are the only shareholder of the company. Therefore, you will need to set your up your corporation as an employer with the IRS, pay federal, and potentially state, payroll taxes, make timely payroll tax deposits and file quarterly and annual reports with the IRS, and possibly state employment department.

For most people this is quite a headache. Interest and penalties on late deposits and filing are quite onerous. This is one item you don't want to let slide. If you have the cash available, it's easiest to make the payroll tax deposits when you deposit your paycheck.

You can avoid most of these headaches by hiring a payroll service like ADP or Paychex. Intuit's QuickBooks accounting program also offers an integrated payroll service.

You will also need to know some of the rules about what things are subject payroll and income tax and which are not. For example, if your company pays health insurance premiums on your behalf, those premiums are subject to income tax withholding, but not social security and Medicare withholding. In addition, this amount is included in the Officer's wages portion of the corporation's tax return, not the employee benefits line. You can deduct the amount paid for your health insurance on line 29 on your individual Form 1040 (this assumes you own more than 2% of the shares and your corporation is indeed an S-Corporation).

With just this one example, you can see how convoluted things start to get. It isn't impossible: but it can be confusing and should give you an idea of how much you'll need to keep track of as a corporation.

Payroll Taxes: How Many Can You Name?

If you're doing a strict cost-benefit analysis to make your determination you need to know about payroll taxes. You're probably already familiar with a lot of them if you've ever received a paycheck but here's an overview from the employer's perspective.

Social Security and Medicare

You're probably familiar with these. For 2006, an employer is required to withhold from employee wages 6.2% of earnings up to $94,200 for social security tax (AKA FICA) and 1.45% on all earnings for Medicare tax.

As mentioned above, employers must match this amount. If you pay yourself a wage of $100,000, you will pay $5840 in social security tax plus $1,450 in Medicare tax for a total of $7290. Your corporation will pay another $7290 in employer taxes. So for $100,000 in wages the total FICA (AKA social security and Medicare) tax is $14,580.

You have to pay these taxes, along with any federal income tax withheld, on at least a monthly basis through EFTPS, Electronic Federal Tax Payment System. You report these payments and payroll tax liability quarterly on Form 941.

Federal Unemployment Tax

This is another tax most people don't realize employers pay. The federal unemployment tax is part of the federal and state program under the Federal Unemployment Tax Act (FUTA) that pays unemployment compensation to workers who lose their jobs. You report and pay FUTA tax separately form social security and Medicare taxes and withheld income tax. Employees do not pay this tax or have it withheld from their pay. The tax is 6.2% of the first $7,000 of wages per employee. You can get a credit for state unemployment taxes you pay that brings the rate down to 0.8%. So if you're the only employee that's $56. You report this annually on Form 940-EZ as you should be able to qualify for the simplified form.

State Taxes

Again, every state is different. You will likely have an unemployment insurance and potentially other taxes the employer pays. In California, there is State Short-Term Disability insurance (SDI) the employee pays that you must withhold and remit to the state. Check with your state's employment department. The IRS provides links to the various state websites here.

While you're at your state site, look for or ask about other requirements imposed on employers, like worker's compensation insurance. Also ask about exemptions for owners. In California, corporate shareholders can get an exemption for certain payroll taxes and worker's compensation on themselves. More forms to fill out, but at least you only have to do it once.

Filing Income Taxes for You and Your Corporation

There are basically two kinds of corporations as far as income taxes are concern: C-Corporations and S-Corporations.

  • C-Corporations file a separate tax return and pay taxes at a different rate structure than individuals. The marginal tax rates range from 15 to 38%. Personal Services Corporations (PSC) pay a flat tax of 35%.
  • S-Corporations are corporations with less than 100 shareholder and a calendar tax year that make an election to be treated as an S-Corporation on Form 2553. Income and expenses are passed on to shareholders. Shareholders pay taxes at their personal rates for their share of the S-Corporation's taxable income. For the most part, the S-Corporation does not pay federal income taxes directly.

Personal Services Corporation and the Flat Tax

The only reason we care about any of this is because of the Personal Services Corporations (PSC) classification. Most people aren't too thrilled with the idea of paying a flat 35% income tax so want to avoid the being a PCS.

A PSC is a corporation with a majority of its income from personal services provided by employee-owners. Personal services are defined as, among other things, consulting and engineering.

By definition, an S-Corporation is never a PSC. Additionally, there are other regulations that by definition don't apply to S-Corporations that simplify matters. Because of the PSC gotcha, all the information in this page assumes your corporation qualifies to be an S-Corp and makes the election in a timely manner on Form 2553, instructions here.

S-Corporation Tax Reporting: Information Only

S-Corporations report their income and expenses on Form 1120S, (instructions here). The rules for what is income and what are deductible expense and what are not, including the home office deduction, is pretty much the same as the rules for other businesses. See IRS Publication 535, Business Expenses for all the details.

The thing that is sometimes tricky for people to understand is that the S-Coropration does not directly pay any income tax (there are exceptions but they probably wont apply). Instead, the S-Corportation reports its taxable income to the shareholders on a Schedule K-1, (instructions here). Each shareholder is required to report the K-1 amounts on their personal return. This pretty much precludes doing your return by hand (although I'm not sure if anyone even does that anymore). Getting each amount from the K-1 to the appropriate location in your personal return is pretty tricky. If you use tax preparation software like Turbo Tax or Tax Cut, it's pretty straight forward as the software handles the details for you.

What this means is you will end up paying income tax at your personal tax rate on the yearly profit of the company irrespective of any distributions paid to you. So if your S-Corp has profits of $200,000 you are going to have to pay taxes at your personal rate. The good news is, subject to certain limits, if your corporation has tax losses, you can use those loses to offset other taxable income on your personal return.

More Ways to Save: Retirement Savings Plans for Corporations

As a corporation, you have more retirement plan options than a self-employed individual. The most popular plans are available to both the self-employed and corporations. Some plans like a regular 401(k) is likely too expensive and administratively heavy to recommend to a small business.

The contribution limits for the self-employed and corporations are different for each plan. However between salary reductions and profit-sharing contributions, corporations are able to defer as much, and sometimes more, income than the self-employed. You can significantly reduce your taxable income by maximizing retirement plan contributions. To get more information see IRS Publication 560, Retirement Plans for Small Businesses.

Estimated Tax Payments for You and Your S-Corp

Technically, you should make estimated tax payments on the estimated taxable income of your S-Corporation that will flow to your personal return. However, by increasing the federal (and state) income tax withholdings from your salary, you can compensate for the anticipated additional income from your S-Corp and avoid making estimated tax payments. Take care here and review this as needed. You can change your payroll withholdings at any time to make adjustments for changes in your anticipated income.

Let's Work Through Four Example Scenarios

Is your head spinning yet? Mine is and I know what's going on here! :) Perhaps an example or two is in order. Let's take a look at the following scenarios and see how just the numbers come out.

Scenario 1: Josephine Baker - The Gorey Details

Josephine Baker is a software engineer that is about to take her first contract. She's already checked that she qualifies to be considered an independent contractor and is trying to decide how to organize her business. She is single, owns her own condo, has no kids and will be working out of her home office. The client has offered her $80/hr as a W-2 employee through their broker (no benefits) or $100/hr as 1099 or Corp-to-Corp. She expects to work 2000 hours for the year to allow some time off.

Let's assume here expenses will be pretty much the same for all three options except she will have bookkeeping and tax preparation fees for the 1099 and Corp-to-Corp options. A detailed breakdown of the calculations is included as an attachment to this page. Note this example only accounts for federal taxes as the situation is different for each state.

What are the tax implications for each option? Take a look at the total taxes liability including income, self employment and payroll taxes:


[table=theme   | W-2 | 1099 | S-Corp
Income Tax | $34,617 | $30,598 | $29,929
Payroll/SE Tax |   $8,160 | $16,422 | $14,580
Total Taxes Paid | $42,777 | $47,202 | $44,509]

At first glance you may say that the W-2 option is the best because it yields the lowest taxes. But hidden in the details is the fact that in both the 1099 and S-Corp options Josie has $44,000 socked away for her retirement but only $4,000 with the W-2 option. In addition, because of limitations she was unable to deduct any of her legitimate business expenses in the W-2 example. But she also had very few complications in preparing her return and she had little or no record keeping to deal with.

You can see that the 1099 option ends up paying quite a bit in SE taxes. Imagine if you hadn't planned for that at the beginning of the year! That would be quite the shock! The point is the 1099 business model makes a lot more sense if you have more legitimate expenses to reduce the SE tax than Josie does. Notice the income tax is actually the lowest with the 1099 option. The SE tax is the killer. With this option Josie does have $44,000 in retirement savings.

The S-Corp option seems to be the best solution on paper. The taxes paid include both the employer and employee portion of the payroll tax. It's only about $2,000 more compared to the W-2 option but Josie has an additional $40,000 tuck away for retirement. She thinks she can do all the bookkeeping and payroll reporting her self but has budgeted an extra $600 for accounting services.

Josie decides to go with the S-Corp option. She's single and lives alone so she doesn't have a lot of other demands on her time. She organized, enjoys learning new things and isn't too intimidated by all the legalese in the IRS publications. Josie's excited about getting her new S-Corp up & running and starting her new contract!

Scenario 2: Josephine Baker - Short Term Contract

Let's use the same details as the Scenario 1. However in this scenario Josie is going to be going to graduate school in the fall and wants take a contract for the summer. This will be her only income for the year. She lives and works in California which has an $800 minium tax for S-Corporations.

Establishing and then dissolving her corporation will be a big hassle and time consuming. Even though she could save quite a hunk in taxes, Josie doesn't think it seems worth it to create an S-Corp for the short duration of the contract.

Since she can save quite a bit more tax deferred as a self-employed sole proprietor than as an employee, Josie opts for the 1099 option. Josie knows she can use her SEP-IRA tax deferred savings next year to help pay for her graduate school tuition without paying a penalty.

Scenario 3: Joe Snow - Loves Fun, Hates Paperwork

Joe Snow is easily board and he hits the slopes winter and summer. Between snow boarding and mountain biking he's always outside. Except when he working at his computer thrashing out code.

Joe absolutely abhors paperwork. He would much rather be out having a good time. But he likes learning new things and enjoys changing jobs frequently. He's a consultant and loves it. He goes with the W-2 option because he knows it would be a disaster if he tried to do all that tax stuff and record keeping himself. He's too
busy having fun!

Scenario 4: Sam Adams - The Need for Benefits

Sam Adams has been offered a job at Pre-IPO Company. They are willing to bring him on as a consultant for a specific project or hire him as a regular employee with full benefits and a reasonablly good stock option plan.

Sam has a wife, 2.3 kids, a mortgage and a dog. His wife is pregnant and his youngest son has juvenille diabetes. This means getting and keeping good health insurance for his family is paramount. He's tried to get an individual insurance plan for his family before and has been denied because of his son's pre-existing condition.

The benefits Pre-IPO Company offers its employees are much better than Sam could ever get on his own. Therefore Sam opts for the benefits and the stability of regular employment and will become a salaried, full-time employee of Pre-IPO Company.

The Choice is Yours

None of the examples above will match your exact situation, but it does give you an idea of both the quantitative and qualitative trade-offs associated with choosing your business structure as an independent contractor.

Remember, keep your personality and life style in mind as you're balancing these trade-offs. The hair you save may be your own!!

Good Luck!


Feel free to contact me if you have any suggestions, questions or comments. This is a complicated topic and I've tried to make things a simple as possible and still be complete. If there are any points that you feel have been left out or need clarifying, please let me know and I'll update this document.

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Nice business website. Well

Nice business website. Well created. Good information too.
Tampa Web Site Design

Hi Linda I am having an LLC

Hi Linda
I am having an LLC for last 2 years and working full time for another company. I dont have any employees in US, but doing some software development works offshore and getting some income through that in the LLC.

Now I am planning to take up a contract job. My company where I am getting the contract job is interested in paying on 1099 or Corp to Corp. What is my best option. Go for 1099 or corp to corp?. I have to stay out of state and travel to do this job. can I deduct my expenses if I take my payment on 1099?

Please help
Jay

S Corp and unemployment status

Linda,
Your article has been very helpful, perfect for me as I startup my one person consulting.
Question: I'm currently on unemployment from a layoff of a big company. If I file the paper for incorporation, and don't have a contract yet, do I lose my unemployment check ?
Question: My startup costs were equipment bought in 2008, and I will incorporate in 2009. How do I handle startup. I did get a seperate credit card in 2008 for my corporation.

Why No LLC?

Hi Linda, just curious as to why you neglected to discuss LLCs in the main article. Are they just a complete no-no in the types of scenarios offered? If so, when would they be a good option? Or are the laws regarding LLCs just in too much flux to be able to provide reliable advice regarding them?

Thanks in advance, and for the information and service you've provided here - very helpful!

- JG

No LLC Tax Entity

Hi JG,

The reason I don't discuss LLCs is this entity type is not recognized by the IRS. There are plenty of reasons to opt for the LLC organizational structure, but strictly from a tax perspective, LLCs are treated as a corporation, partnership or sole-proprietorship by the IRS.

Now, why the IRS ignores LLCs is an interesting question. I'd like to hear a good answer to that from the IRS. :)
L:)

Are you sure??

What do you mean when you say the IRS ignores LLCs? You have to make sure to file as a corporation. If you do not and are a single member LLC you are automatically a “disregarded entity”. However, if you are a single member LLC and file for 8832 or are a multimember entity you are a corporation just like the rest am I wrong?

While working for this

While working for this company I was paid as a contractor, and received a 1099 MISC with my income noted under the "non employee compensation" section. Not long ago I applied for a home loan and learned that banking underwriters base my income level on my net income.

I took a class where the

I took a class where the various options were described. The instructor said that the company's tax filing procedure doesn't have to be the same as the legal structure (sole proprietor, LP, LLP, LLC, etc). I.e. I could incorporate as an LLC, but file taxes as an S-corp by "sending in the 1120 form".

S Corp Deductions

Hi Linda!

Just wanted to know what is the maximum amount allowed for total deductions for a new S-Corp?

Thanks again,
Tony

Deductions

Hi Tony,

There is no maximum deduction limit. Legitimate deductions are what they are.

Now, if the deductions yield a loss, your loss is limited to your basis in the company. Anything beyond that is suspended and you can take the loss once you have sufficient basis.

If you talking about the start-up & organizational costs, you can deduct up to $5k each.

I hope that answers your question.
L:)

W-2 with benefits verus corp-to-corp without?

Love this page. It was the top hit in Google when I searched for "1099 versus corp-to-corp" and I see why. Thank you so much for your continued support of it, Linda.

Background: My employer (a Contract agency) had me contracted out to Big Company. Big Company had a rule that said you could only be a contractor for 18 months. My 18 months was up. So they told a professional services company that they had an existing relationship with to hire me so that I could continue to work for Big Company as part of the professional services omnibus contract. End run around the 18 month rule.

This all happened within hours and all unbeknownst to me. Meanwhile, for other reasons, I had a sole proprietorship that I just days before incorporated. Paperwork is finished and approved but I haven't seen a certified copy from the state (New York) yet. Web site says it's done.

My question is this: Professional Services company is not up to the billing rate of what I was getting from contract company, but they're willing to let me get what I was being paid. We'll say it was $50 per hour.

They've offered me a W-2 basis at $50 per hour with benefits that I have to pay the entire premium on myself (they claim to be unable to afford to pay their share of it themselves). That's about $300 per month (I can't believe that they can't pitch in $150 per month. Anyway). Or they'll do 1099 at straight $50 per hour and I'm on my own for benefits. Or they'll do corp-to-corp at $50 per hour and they seemed to like that idea when I brought it up. The notion of more than $50 per hour for corp-to-corp has not yet been brought up.

I don't mind the paperwork/accounting/whatever associated with any of these ideas, and I like the corp-to-corp, since owning and operating my own business was always my goal. I only wonder if it makes sense to do corp-to-corp when there is, as of now, no increased pay rate to make up for the increased responsibility that I am taking on.

I need to move quickly on this (before the 15th) so any advice would be appreciated, but I understand if you can't get to it. I've updated your spreadsheet with my specifics and the costs seem to point towards corp-to-corp but I just wanted to know if you had ideas.

Thanks, and sorry for the long note.

-Eric

Which entity type?

I am getting ready to start a new small business. I previously worked for a company performing a similar function that my company will perform. While working for this company I was paid as a contractor, and received a 1099 MISC with my income noted under the "non employee compensation" section. Not long ago I applied for a home loan and learned that banking underwriters base my income level on my net income. This produced a dilemma as I would write off as many deductions as possible, thus reducing my AGI, but also reducing my ability to qualify for a higher loan payment.

Now that I'll be establishing my own business, I want to choose the entity type with the goal of finding a good balance between reducing my tax liability to the greatest extent possible while also being able to show a normal, stable income. Previously I've been forced to pay SE taxes, which seem excessive.

What was the advantage in my previous company (an LLC) paying me via 1099? Did that enable some tax savings for them or was their motivation simply the reduction in admin hassles?

Some brief input about my business. I will raise money from private investors, that money will be combined in a pool, and then the company will make real estate investments with those funds. I would prefer their investment be in the overall company rather than individual investments or projects. My income will be sporadic, and can vary greatly from year to year.

Any input/advice you can offer is greatly appreciated.

unemployment compensation

I need to make 250.00 to be able to collect on my second claim of unemployment. I live in an area with high unemployment and no one once to higher. I have a friend that has asked me to work for the month of Dec. to help out in their meat business. He said he would give me a 1099 contractor form and write me a check. Does this go towards my unemployment compensation so I can start my second claim of unemployment? I am currently on the second federal 7 week extention. any help in my desicion would be greatly appreciated.

Unemployment

Not usually. Only wages that are subject to UI tax will qualify you for unemployment. Better to have him pay you W-2 wages if that's an option.

Good Luck!
L:

Unemployment and 1099

I am currently unemployed and looking for work. A friend of mine told me that when he was receiving unemployment, that he actually took checks from an employer paying him 1099 status. He is encouraging me that there is a legal way to be on unemployment and still collect checks as a 1099 contract worker. Is this possible? I believe he was selling houses at the time and merely claimed the total amount he would have been given on UI at the time and so didnt get paid for the week. Am I being clear? Please advise, I am checking w/ multiple resources because it sounds funky and I dont want to put myself on the wrong side of UI, the EDD, or the IRS. Thank you for your time and attention to this!!

Unemployment & Contracting...

You should check with your state's unemployment office, but generally being self-employed makes you ineligible for unemployment income.

I would be interested in his "legal way". Sounds fishy to me too but maybe he's found a legit loop hole.

L:)

These are one important

These are one important factors for investing or making your own business.This is a good read.

Loans

Starting my own consulting business - job shop

I am about to embark on my own consulting/job shop business, where I will find candidates and submit them to clients. From my own software contracting experience, I have worked for a client via a consulting firm, and received my paycheck from the consulting firm. But these firms had no 'bench' so once the contract ended, so did my "employment" with the consulting firm (was I really their employee one wonders?)

My question is the business formation - should I do this as a sole proprietor? I am leaning heavily towards forming an LLC checking the "filing taxes as partnership" (sole proprietor) box. I am in Texas and the filing fee is manageable, not sure yet about yearly franchise taxes such as California's $800 - but off hand I don't think Texas has that. LLC gives liability protection but is there much of a liability issue with software consulting? My wife wants protection to keep us from liability issues so she thinks the LLC would be 'safer'.

(I have Quickbooks Simple Start (free) to help me with bookkeeping, and I might hire an accountant to help if needed.)

So, LLC, sole proprietor or something else (s-corp)?

Good article

I was looking the information that was mentioned in the above article in other sources, but this article was the most helpful so far. Thank you. http://www.unclepayday.ca - instant cash loan

LLC and EIN

Hi Linda,

Thank you a million times for this comparison on W2, 1099 and S-corp. I have a LLC but never filed for an EIN as I am the only person working for my company. Isn't this the same as a sole proprietorship? Do I have to apply for a EIN if I do 1099 work? In the pass I've filed my 1099s along with my regular income taxes and not do quarterly taxes as work was not steady and I had full time employment elsewhere. Is that acceptable?

Question on S Corp retirement plan

Linda,

This is the best article I have read explaining the pros and cons of various options for consultants. I recently started consulting and have formed an S Corp for that. The question I have is on retirement plan contribution - how do I go about contributing towards my retirement plan? Can the S Corp simply write a check or does it have to come through payroll deductions? I am not paying myself enough to reach the contribution limit via payroll deduction.

Also, my wife is also an employee. Does she get a separate retirement plan with the same limits?

Regards,
Paresh

S-Corp Retirment Plans

Hi Paresh,

Thanks for the kind words. :)

The S-Corp can make contributions directly to your retirement plan. The type of plan you have depends on how and how much the S-Corp can contribute. For instance if you have a SEP, then the corp can contribute upto 25% of your gross wages (upto $46K). If your wife is an employee then the corp can make similar contributions for her.

Hope this helps
L:)

S-corp related

Linda,

This is a fantastic blog I have seen for consulting and corporations related Qs. Thanks for the effort.
I am on H1b status and working for a company on full-time basis. I am setting up S-corp IT services company and have some quick questions, please provide some insights into these:

1. Is it better to hire someone as recruiter for my firm on part-time basis and pay minimum wages plus commission based on performance (or) give a percentage based on performance, but for later scenario unless my employee achieves goal he/she would not be able to get any pay. So does the later scenario have any legal and tax issues
2. In contracting cases, My company will act as Middle men for client and another consulting company (whose employee will be consultant providing services to my client). When I get payment from client, I would have to deduct all the expenses and pay to the consulting company I am in contract with. How do the taxes go with the income I have now.
3. Can I hire someone in canada/uk or other country who will manage the company and run Do I need to have atleast 1 employee in USA to run the business.

Hi Anonymous, If you are on

Hi Anonymous,

If you are on a H1B, you must be a full-time employee of the company that sponsors you for your visa. While you could theoretically also start your own US corporation, you would have to hire other people to do ALL the work. You would not be able to receive any wages from the corporation, although you would be able to benefit from your equity stake.

I would strongly advise that you talk to an immigration attorney before you take this step: it could get you into all kinds of trouble.

LLC (sole vs s-corp)

Hello Linda,

This site is great. I have a question about which entity would be better for me. I started my LLC about a month ago and the guy that filed my LLC paper work only asked me how much I would be making and if I pay my own health care, after that he advised I file my LLC as a sole. Previous to this new contract I was making 65/hr as a w2 contractor paying the contracting company for family health care, until a previous co-worker offered me a contracting position as an independent @ 75/hr and now I am on a cobra plan for the next 18 months. 1. After viewing your tax examples it looks to me that the better option is to file as an S-Corp? I don't think I will be able to have any home deductions, although I do work from home one or two days a week, but I do not have enough room in my house to have a dedicated work space. Also the remaining days of the week I have to travel 90 miles round trip. 2. Am I able to take these deductions?
I moved from a w2 contractor to an independent LLC contractor in July '08 and I have been paid once, am 3. I still required to pay quarterly taxes this Sept 15th?
Now that I look at your tax examples I think I was better off at 65/hr as a w2... lol

LLC (sole vs s-corp)

1. S-Corp is probably more advantageous strictly from a tax perspective. The SMLLC is probably easier to manage. You could just file Form 2553 and opt to have your LLC treated as an S-Corp. But then you're going to have to deal with payroll.

2. Perhaps. If you don't have a qualified home office, then no, the home office & commute miles are definitely not tax deductible. If your company is treated as a corporation & your home is the corporate office, your company could reimburse you for the expenses related to a home office. Travel from your "corporate office" to the client location would then be deductible.

3. The estimated taxes are based on when you receive your income. The Sept 15th payment should cover the income & SE tax on the net income received between June 1 & August 31. However, if your other W-2 tax withholdings >= 110% of your 2007 tax liability you don't need to make estimated payments. Otherwise, you should make the 9/15 estimated payment.

Hope this helps.
L:)

Excel Scenario1 Request

Hello Linda!

I like your attached Scenario spreadsheet that you have supplied us. I was wondering if you would have a another template where we could add in our numbers to the specific blanks and keep your formulas? This will help give me a better understanding where I stand. I tried to trace and change items through the existing one but get I get lost.

Anything you have would be appreciated.

Thanks,
Tony

W2 vs. S-corp

I have a quick question with regard to W2 vs. S-corp.

I have a full time job in New York city which pays for my health insurance etc. and I elected to get 15000 as 401k from it.

Now I have a part time contracting offer from a corporation for around 2 month. They can let me choose either being W2 on one of their payroll service provider or doing a corp. vs. corp with me.
What should I choose? As I understand, the rate is going to be $200/hour for the job. For W2, the service provider will pay 13.85% for FICA, and charge 5.5% for the service and the liability insurance. So totally it is 19.35% off the $200/hour rate. If I do corp. vs. corp with them, the service provider will still charge 8% off the $200/hour rate, and then I have to get my own liability insurance and pay the 13.85% FICA by myself. So what should I choose? there won't be much business expense involved, basically statistical work involving my own computer.

By the way, I already have a S-corp setted up in New York city. Thanks.

W-2 or S Corp

Hi Larry,

If you have more than one employer in a calendar year, the $102K social security cap applies separately to each company. That means that both your regular and your S-Corp would be responsible for the 6.2% social security tax on the first $102K of income. Any amount withheld from your paycheck can be recouped on your tax return, but the amount that the company pays just goes to the social security trust fund. There's no way to get that back.

Since you need to take a reasonable salary from your S-Corp this would likely apply if you take the corp-to-corp option.

In your case, it sounds like one is not necessarily better than the other unless you have other expenses in the S-Corp to offset the income from the contract.

Hope this helps.
L:)

Corp-to-corp question

Linda,

Thank you for the excellent information throwing light on a confusing subject.

I am an independent recruiter who recently opened shop out of my home as a sole proprietor. Until now, I have only placed professionals as "direct hire" in permanent positions, for a fee. Simple enough - I invoice for my service and take in the revenue as personal income. I now have the opportunity to place a candidate on an hourly basis with my client (for at least one year), on a corp-to-corp basis, as requested by the candidate (he is set up for corp-to-corp already). In this situation, would the candidate bill me at an hourly rate as a corporation and I in turn bill my client as a corporation? Or does my client pay the candidate directly and I bill for my margin separately? If I must set up a corporation, I supposed I can set it up as an S-Corp?

Thanks in advance for your help!

Head Hunter

Hi New...

First you don't necessarily have to form a corporation if you don't want to, but yes you could.

I think most job shops bill the client directly and pay the contractor once they receive payment from the client. The down side is you're managing all the paperwork. But at least then you make sure you get your cut of the deal. If you bill the contractor for your cut, then you don't know if they'll actually pay but it's less headache if you do.

I wonder if it would be worth getting a flat fee from the contractor paid in advance.

Hope this helps.
L:)

Hi there, Thank you for all

Hi there,

Thank you for all your information. I already have an LLC set up in California. Not designated as S or C-corp. Would I need to change this? I will be possibly getting a contract by the end of next week and they too have asked the 1099 or Corp-corp.

So from my understanding I will now become an employee of my LLC and it will be paying me a salary.

Do you recommend that I hire a cpa or a bookkeeping service? I'm very busy and don't have the time to take care of all this.

Where would be a good start to look for an accountant that is accredited?

I have had previous contracts where I received a 1099. What would change now that it will be corp to corp.

Thank you.

Single Member LLCs <> Corp-to-Corp

Hi Jay,

I'm a little confused as to your question, but I here goes...

No. If you have an LLC and you have not make any election to be taxed as an S Corp, then the LLC is taxed as a sole proprietor and you are not an employee of the LLC.

The LLC contract would be exactly the same as your previous 1099 contracts. The only difference is you provide your LLC name & EIN to the client on Form W-9 and on your Schedule C. You will also need to file and pay the $800 minimum LLC fee in CA.

I hope this helps.
L:)

How to set up a S-Corp

Hi Linda:
Great job in explaining various ways to go independent. I am completely new to the concept of contracting. All my life so far I have been a full-time employee. Now, I am looking at contracting options. Having said that, can you direct me to a resource (site or books) that would help me with step-by-step process of setting up a S-Corp in the state of Georgia? Also, is it better to go with a professional or can I do it myself?

Thanks

Sharma

Hi Sharma, There are lots of

Hi Sharma,

There are lots of site now that will do a help you with the processing. >a href="www.nolopress.com">Nolo Press has great books about incorporating in general. The "Incorporate & Save" link under the services heading to the left send you to the MyCorporation website (a subsidiary of Intuit). This service will do the incorporation paper work for a fee. I get a referral fee if you use that link. :)

Some of the things you can easily do yourself, like getting your EIN & filing the S-Corp Election on Form 2553.

Hope this helps.
L:)

W-9 Revisited

Hi Linda...just want to follow-up on our last discussion...

I am organized as an S-Corp and have not provided any W-9 information to the company in which I am contracting with. They are not withholding 28% for federal taxes. Since I am not a Healthcare or Legal firm does this mean that it is up to me to report what the client is paying our firm? If so, what form would I report this on?

Thanks again!
Tony

W-9s

Hi Tony,

Technically, your client was supposed to ask you for the W-9. A lot of people just don't know about the 28% back up withholding requirement.

You might want to give them one for their records. But all you need to do is report your gross receipts on your From 1120S. You need to do that whether they give you a 1099-MISC or not. :) There's no other IRS reporting requirement for the payments you receive.

Hope this helps.
L:)

Simple checklist ??

hi,
so after 15 years in work force I have been laid off. I am thinking of doing consulting, but the information looked overwhelming. Some thing tells me that there has to be one easy way of doing this. Meaning, if I start formming LLC now, I will pay formation money (online at least $400+ CA state taxes). Should I just wait to get a gig where the client decides wether they want corp-to-corp ot W-2 and then decide? I have been intervieweing and lot of clients/brokers say we will not do 1099 but only W-2. I am assuming that W2s are not applicable to LLC. Please commment.
Q2. If I formm LLC, can client do corp-to-corp with my LLC?
Q3. Also, one would need a CPA for regular record mentainance and filing? Is this true? So, is it better to just hire one now and have him/her do formmation etc for me? Typically how much this monthly service cost? Am I on right track?
regards,
Sam

LLC: Form it now or later?

Q1: I would wait. Why pay to form an LLC & the tax if you're just going to close it down. You might want to pick a name and reserve it with the Secretary of State. Yes a W-2 arrangement only works with an individual.

Q2: Your client can do corp-to-corp if you file the forms with the IRS to opt to have your LLC taxed as a corporation (S or C, but if you're consulting, probably an S Corp)

Q2: No, you don't need a CPA. You can do most of the bookkeeping yourself if you're a detailed oriented person. Usually it's the payroll that's the tricky part. You can either get someone to help you or use a service. BofA has a program that's $15/month for payroll. I wouldn't try to keep track of everything in a spreadsheet. You're better off with a small business accounting package. As far as rates go, it's all over the map & depends where you are on the map. :) Intuit publishes rates surveys of various accounting services. It might give you an idea of what you can expect to pay. You might also look into doing the books yourself & have your accountant do a quarterly review to make sure things are on track. That way if there's a problem, you can usually fix it relatively quickly & keep a little mistake from becoming a big problem.

Good Luck!
L:)

Federal E.I. Number Reporting

Hi Linda...welcome back! Hope your vacation was enjoyable!

In regards to the company that I am contracting with, I just wanted to know what is it exactly that they are reporting in reference to my EIN; and how often they are to report this information.

Thanks,
Tony

W-9

Hi Tony,

I'm assuming you're talking about giving your EIN to your client on Form W-9.

The client will use the EIN to report non-employee compensation >= $600 to the IRS on Form 1099-MISC. If you don't give them the W-9, they are required to withhold 28% for federal taxes from their payments to you.

If you business is organized or taxed as a corporation, the client does not have submit 1099s to the IRS (except for payments to lawyers & for health care).

The 1099's are reported annually to you by Jan 31 & to the IRS by Feb 28. The W-9 need be provided to the client once per contract.

Hope this helps.

L:)

...additional info

I am organized as an S-Corp and have not provided any W-9 information. So the reporting is up to me?

Thanks again!

Hello Linda! If you have a

Hello Linda!

If you have a S-Corp, do you have to have a minimum of 1 employee?

also

In stead of listing myself as an employee, can I just say that I am an officer, and just pay myself quarterly dividends instead?

Thanks and have enjoyed your posts!

Vince

S-Corp Officers

Hi Vince,

Sorry, nope. By law, corporate officers are employees & must be paid a reasonable wage.

L:)

Can C Corp make sense for Consulting Businesses?

Hi Linda,

I wish I had read your article before deciding whether to be a C or S-Corp. I am a Software Consultant.
Last year, my husband and I setup a corporation in Minnesota. My husband and I are both owners of this company, but he is currently working for another company as an employee. We had no business activities last year.
This year, I had my 1st corp to corp contract in January 2008.

We spoke with a Tax Advisor in January. After evaluating both our personal taxes and expected income/receipts from my consulting services this year, she gave us an advice that we should be a C Corp instead of an S Corp. We had told her that our primary business is consulting.

I'm getting worried that we will be hit with a 35% tax after reading your article mentioning about Personal Service Corporation. This is the first time I have heard of such a term and am wondering whether the advice given by our tax advisor is a bad one.

Is there any circumstance where we would be better off being an C Corp as a consulting business?

Thank you.

C Corp for Consultants

The rules for benefit plans are different for C vs S Corps. The only thing I can think of is if you have an usual situation, like high personal medical bills that the corp could pay for.

Otherwise, you could be subject to the PSC tax. On the face of it, probably yes. But I don't know all the details of your situation. If your personal marginal tax rate is > 35%, then yes, you would probably pay a little less in ordinary income taxes as a C Corp now. But when you get the money out, you'll have to pay dividend tax.

You can file Form 2553 to make the election to be taxed as an S Corp effective 2009. Or you can try to get late election relief under a variety of IRS Revenue Procedures for the S Election to be effective for 2008. These all require, reasonable cause for why the election was late.

Good Luck!
L:)

Change of Employment Type

Thanks Linda, your response is a great help! :)

My other question is currently I'm working on confirming another contract. My 1st contract earlier this year is on Corp-to-Corp terms.
If I were to accept another contract as a W2 or 1099 for the rest of the year, does that nullify my ability to contribute to my Individual 401K plan or give myself a pay check as an officer of the corporation for the rest of year?

Thanks in advance!

Have a great day!

already an employee with a side consulting business

Hi Linda -

I'm already a full time employee for an employer and pay out the maximum amount of social security tax for FICA purposes. I am also starting to do some consulting on the side and am planning on creating an S corporation for that purposes. Is there anyway to reduce the amount of FICA I pay on my salary from my newly formed S corporation.

For example, let's say my employer pays me $110,000 so I max out on the social security portion of FICA. Then I get paid a salary by my s corporation of $50,000. Will my S corporation have to pay the entire employer's portion of FICA on the $50,000?

If so, would an LLC taxed as a partnership (my spouse could be the other partner) be more beneficial from an employment tax perspective (since I have a full time job)?

Thanks!!

We haven't heard from Linda

We haven't heard from Linda in a while...is this site closed?

She has just been on

She has just been on vacation. She'll be back on the job soon.

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