1099 vs S-Corp Taxation (W2 Sole Employee Owner)

I’ve always done 1099 consulting work in the past and am strongly considering forming an S-Corp or an LLC (which I elect to file taxes as an S-Corp) and paying myself as a W2.

The major benefits to being a W2:

  1. If Health Savings Account (HSA) funds are paid for out of the S-Corp, they are become exempt from 15.3% Self Employment (SE) Tax.

  2. If Health Insurance funds are paid for out of the S-Corp, also exempt from SE Tax.

  3. The Employer portion of Solo 401k contributions (~$37k/year) are exempt from SE tax.

  4. If you stop getting work, for any reason, you may be able to file for unemployment.

  5. Trump Tax Plan may allow for some tax sheltering but I haven’t read it to be clear

  6. Asset protection of personal assets for liabilities caused while working as a W2 of the entity, however as a consultant, the chances I do any damage and get sued are virtually zero.

Downsides to being a W2 / Forming a Corporate Entity:

  1. Likely necessary to register as a foreign entity in the state you’re working. California, I believe, charges around $1k per year to any non-CA business entities who want to business in CA. Whereas this does not apply to sole proprietors.

  2. Withholding taxes throughout the year make you less able to maximize float interest relative to paying quarterly taxes.

  3. Opportunity cost of Manufactured Spend (MS) potential to pay quarterly taxes on a credit card.

  4. Difficulty to perform withholding taxes, and may require paying a service like PayChex to do it for you at a cost of $500+ per year.

  5. Likely require unemployment insurance premiums be paid to the state.

  6. May require workman’s comp premiums be paid to the state.

  7. Cannot collect/file for unemployment unless you dissolve the corporate entity.

  8. Currently have a high deductible health plan (HDHP) and HSA. I highly doubt the HSA custodian would allow my S-corp to make contributions on my behalf to save the SE Tax, so I’d have to find a new custodian that would allow a single employee corp to open an HSA, and they will probably charge me fees exceeding the SE tax benefit.

  9. Doubtful my insurance company, who is selling me an individual plan, will allow me to shift that plan to my business entity, so I can avoid SE taxation. In fact, if I form a business entity and W2 myself for the other non-health insurance benefits, then I must forgo the self-employed health insurance deduction, unless I can get a plan through my business entity. And my plan is very old, grandfathered in, pre-Obamacare, and 1/3 the cost of a new plan, so unlikely I can improve my position with a business entity. Perhaps I can just “say” the insurance was paid by the business - perhaps even linking the business checking account to the health insurance plan, and this way the insurance company doesn’t have to know it came from business funds, and if the IRS looks, it’s close enough to legit even though the policy doesn’t have the business name on it.

  10. Annual filing fee to your home state. Varies by state - I believe it ranges from free to $300/year and generally is around the $100 mark on average.

  11. You will waste an enormous effort paying for bulls*** fees like UI tax and workman’s comp and filling out extra paperwork and possibly paying for withholding payroll processing, for the sole reason that our government is run by idiots who make you do all of this bureaucratic nonsense rather than letting you as a Sole Proprietor take the same deductions. Then you feel bad. Like when you wait at the same red light in your residential area every day, that no one is ever going in the opposite direction, but the idiot city engineers didn’t design properly, and now you waste 2 minutes per day sitting there, powerless to the Idiocracy you live under.

Unclear Points

  1. If I wanted to apply for a mortgage (which I do not, so this is a moot point for me, but may be relevant to others), it’s unclear if W2ing yourself from a single employee-owner S-Corp is better or worse than being a 1099. In general 1099 income is considered less stable than W2 income, however if you’re W2ing yourself, it seems like it may be considered even worse than a 1099. And, you’re likely going crazy with the deductions and retaining funds to save FICA tax, so your final W2 will be a lot less impressive than a 1099.

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Just to start with this one - if you’re the sole owner, this may not be correct.

Looks like you are correct! If you are >2% owner of an S-Corp or a sole employee/owner of an LLC, you can’t contribute to an HSA via the business and get a FICA tax deduction.

Now I have to figure out if my health insurance can be paid by my business or not. I assume it can be, but whether I can get my current insurance company to switch it from a personal to a single-person business account is the issue, and given how bureaucracies work, I imagine it may not be feasible.

I forgot the main reason I didn’t make an S-corp in the past. The SE tax deduction on employer contributions is somewhat of a myth. While it’s true that if the SCorp contributes the $36.5k directly, that’s FICA/SE Tax deductible. However, if you’re making enough money to maximize the 401k contribution of $55k, then you’ve exceeded the SE tax maximum, so you’re not saving 15.3% on the contribution, you’re only saving ~3% since Medicare tax is unlimited (thank you for that legacy, President Obama, that’s how I will always remember you).

Thus, the cost of doing payroll isn’t quite worth the 3% tax savings on $36k

Newbie here, just about to start my way as W2 Employee. I was told by my employer that it will be more convenient and secure way to do business with me and to me personally. Furthermore, it will simplify my way of filing to the IRS because it’s easy to file w2 form online fillable-form-w2.pdffiller.com But, looking at this list of shortcoming of being a W-2, I’ve started to be in doubts