Become Independent Blog

Understanding Contractor Types

2013 Michael Schneider Contracting, Independence

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The most common question a vendor (staffing agent) and/or client (employer) will ask you (independent contractor) when starting a new assignment is whether you want to work as a w-2 contractor, 1099 contractor, or corp-to-corp contractor. Why do they ask this question? First, it defines the contractual relationship between you and the vendor in terms of payroll, employment benefits, and tax consequences. Second, it clarifies the relationship between you and the client (employer) as it relates to independent contractor compliance laws and work-related liabilities. Third, it determines who has control (you or the vendor) over where, when, how, and who you work for. So, it is a very important question that will affect both your work and personal situation.

But even though it may be posed like a multiple choice question, there is no simple black and white answer. Take my story for example. I started my consulting career as a full-time traditional management consultant. I was later offered a w-2 engagement with an approved vendor for one of my former clients. During that time, I began building a large network of connections and clients. When I was ready both financially and emotionally, I found a good lawyer to help me transition from a w-2 to a 1099 contractor. Then, with the advent of the new independent contractor compliance laws, more and more vendors began asking me to work as a corp-to-corp contractor. I weighed the pros and cons and converted to an LLC.

Therefore, it is not uncommon for new independent contractors to start off as one type (because it’s appropriate for their current situation) and then change to another later on. But, it is important to understand the differences as shown in the table below.

W-2 1099 Corp-to-Corp
IRS Definition W-2 contractors are defined as leased employees. A firm furnishing workers to other firms is the employer of those workers (leased employees) for employment tax purposes. For example, the staffing service enters into contracts with the clients under whom the clients specify the services to be provided and a fee is paid to the staffing service for each individual furnished. irs.gov source: Leased Employees A sole proprietor is someone who owns an unincorporated business by himself or herself. However, if you are the sole member of a domestic limited liability company (LLC), you are not a sole proprietor if you elect to treat the LLC as a corporation. irs.gov source: Sole Proprietors In general, a corporation is formed under state law by the filing of articles of incorporation with the state. The state must generally date-stamp the articles before they are effective. You may wish to consult the law of the state in which the organization is incorporated. irs.gov source: Definition of a Corporation
If your length of contract is.... Less than 1 yr; dont need to bother incorporating or itemizing your business expenses. Greater than 1 Year Greater than 1 Year
Pros
  • Regular paycheck
  • Job finding assistance by vendor
  • No need to make quarterly estimated tax payments since taxes withheld on paycheck
  • Eligibility for employment benefits such as health care and 401K retirement
  • No need to do any major bookkeeping (unless tracking reimbursable expenses)
  • Ability to negotiate higher bill rates
  • No incorporation documents necessary
  • Can deduct business expenses like home office, meals, and travel
  • More income to save for retirement
  • Get tax benefits of small business retirement plans
  • You have control over who, when, how, and where you work
  • Ability to negotiate higher bill rates
  • You can deduct business expenses
  • You have more income to save for retirement
  • You get benefits of small business retirement plans
  • You have control over who, when, how, and where you work
  • In an LLC, you can add other members (like your spouse)
  • You can hire employees
  • In an S-corp, you can add up to 100 shareholders
  • You are not personally liable
Cons
  • Significantly lower bill rate relative to the non w-2 options
  • With reduced income, you have less to put into retirement
  • Limited control over your availability and earnings since vendor controls most of that
  • Vendor determines where you work (even if you dont agree)
  • You need to supply your own health insurance
  • You are personally liable
  • You need to manage bookkeeping and tax tasks
  • You need to pay quarterly estimated taxes
  • You need to pay self-employment taxes on net income
  • You need stay updated with incorporation filings and state fees
  • S-corp shareholders pay estimated and income taxes
  • LLC active members pay estimated and self employment taxes
  • You need file a separate business return at tax time.