Transitioning from filing taxes as an employed physician with a Form W2 to becoming a self-employed or contractor position with a Form 1099 comes with significant tax implications. While W2s are simpler and the employer, rather than the employee, is responsible for withholding federal and state income tax, payroll tax and any premiums for offered benefits, filing as a 1099 physician is considerably more complicated. Brian McCook, Anders partner and health care practice leader, made an appearance on the Financial Residency podcast with Dr. Tammy Crouse to discuss the main differences between filing a 1099 and a W2, plus actionable tips that physicians can use to make the switch.
Key Takeaways:
- You will need to make an entity selection as one of your first steps, which can create major impacts on tax liability and burden
- W2s are fairly simple for reporting income and paying taxes through employer tax withholding while a 1099 filer needs to analyze and remit tax payments themselves
- 1099 filers can find benefits with preferred pricing or group rates through organizations like Insperity or by visiting your local chamber of commerce rather than on the open market
- As a 1099 filer, you will be responsible for making quarterly estimated tax payments in one of two ways: 100% of the current tax year or 110% of the previous tax year, whichever is lesser
Many physicians who primarily file W2s are already familiar with Form 1099 due to their work as medical directors or because of locum work they’ve performed. Filing a 1099 brings some additional challenges and responsibilities, but the increase in independence and potential tax benefits may outweigh the added liabilities.
To begin, you’ll need to make an entity selection. Remember that taxation varies between different entity structures, so a single-member LLC will be taxed differently than an S Corporation. Take time to familiarize yourself with the different options to make sure you select the right one for what you want to accomplish. While it’s not technically required for single-member LLCs, it’s recommended you still acquire an Employer Identification Number (EIN). The process to get one is fairly simple and is available through the IRS website.
Differences Between Filing as a W2 and Filing as a 1099
One of the key differences between a W2 and a 1099 filer is the responsibility of withholding. When filing a W2, the employer has already withheld payroll tax, federal and state income tax and premiums for benefits provided by the employer, such as health insurance or a profit-sharing match. As a result, filing a W2 can be fairly simple and completed with tax filing software like TurboTax.
Filing as a 1099 is significantly more complicated because as a contractor, you are both the employer and the employee, making you responsible for all the duties listed above. You are also responsible for determining the benefits you want and paying for them, making it more expensive to be your own boss. To offset the increase in cost, you may want to consider negotiating a higher rate as a means to pay benefits and wages to yourself.
Taking advantage of qualified tax deductions can also help ensure you take home your maximum amount of wages. When earning and reporting 1099 income, the taxpayer becomes fully responsible for paying both the employee/employer portions of Medicare and FICA tax, which totals 15.3%. In comparison, a taxpayer who is a W2 employee shares the burden with their employer and is only responsible for paying the employee half of the taxes, or 7.65%. As a self-employed physician, you are eligible to deduct the “employer” portion of Medicare and FICA taxes paid. This is a deduction from income which ultimately levels out the playing field between W2 and 1099.
Accessing Benefits as a 1099
Another area that will require your attention as a new 1099 filer are benefits. As a self-employed individual, you are responsible for securing and paying for any benefits you want to give yourself, such as health insurance. Visiting your local chamber of commerce may help you find a group you can buy into which provides more bargaining power as an individual or small business owner. There are also companies like Insperity that offer opportunities to find preferred pricing instead of trying to find the best deal on the open market by yourself. The cost of self-employed health insurance is also 100% deductible as a sole proprietor.
Making Estimated Tax Payments
With income from a 1099, you are required to calculate and pay federal and state taxes quarterly. Due dates fall on April 15th, June 15th, September 15th and January 15th of the following year. You’ll need to analyze tax liability throughout the year to determine if estimated tax payments are necessary. Failure to pay sufficient taxes can result in underpayment penalties and interest.
There are two main options for 1099 filers when it comes to paying Federal tax estimates. The first option is paying in 90% of your current year’s tax. The second option is utilizing a safe harbor where you pay in 110% of your prior year’s taxes if your taxable income the previous year was more than $150,000. If taxable income was less than $150,000, you only have to pay 100% of your current year’s tax. You may pay the lesser of either 90% of the current year’s tax or 100 to 110% of your prior year’s tax based on the prior year’s income to stay safe from penalties and meet the safe harbor requirement.
Keep in mind: although you may choose to pay the lesser amount to meet safe harbor requirements, by paying the lesser amount through quarterly estimates, there could still potentially be tax liability due when filing your tax return. The lesser option may still be ideal for you because, from a cash flow perspective, you can keep the money and make it work for you while you’re holding it. Placing the funds in a money market or another financial vehicle that you can quickly convert to cash may be a more attractive option. Just know that the full tax liability won’t be deferred forever. You will have to pay the due balance when you file your taxes.
Additional Considerations for Multi-State Tax Filing
Each state has different rules regarding estimated tax payments, so it is important to work with a tax advisor to understand the requirements for remitting state-estimated tax payments. Generally, most states follow similar guidelines to the Federal estimated tax rules. If you are earning income from multiple states, this becomes an even more important planning point.
If you filed a W2 the prior year and are filing a 1099 in the current tax year, your prior year safe harbor threshold for estimated tax payments would be based on that W2 income regardless of what you’re making this year.
Anders Health Care advisors work with members of the health care industry to take care of your financial needs so you can keep your attention on what matters most: your patients. Learn about how implementing a tax planning strategy customized to your needs can reduce your tax burden, along with the associated fees, by contacting Anders below.
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