What is the Difference Between W2 and 1099?

In this video, the differences between W-2 income and 1099 income are discussed, focusing on tax implications and retirement planning options. A hypothetical analysis was conducted using a $500,000 household income scenario, comparing the tax outcomes for both types of income.

For W-2 income, it was noted that the employer pays half of the Social Security and Medicare tax, resulting in lower tax liability. In contrast, 1099 income requires individuals to cover the full Social Security and Medicare tax, leading to higher taxes.

However, 1099 employees have more flexibility in setting up their retirement plans. They can establish their own 401(k) plans and contribute up to $61,000 per year, compared to the limits imposed on W-2 employees. Additionally, creating an S Corporation can provide further tax-saving opportunities for 1099 earners.

Ultimately, whether W-2 or 1099 income is better depends on an individual’s specific financial situation and retirement goals. The video encourages viewers to seek personalized advice to determine the most suitable approach for their circumstances.

Video Transcript

In today’s video, we’re going to talk about the differences between a w two income and a 1099 income, which is better? How much taxes are you going to pay, and what kind of benefits could potentially be set up, or are you restricted to depending on what status you are from a paycheck perspective?

First of all, we’re going to start with an analysis between the two. Assuming apples to apples. Ben, walk us through the difference between what a w two and 1099 would pay in taxes assuming the same incomes.

Yeah. So the analysis we ran thanks, Matt was assuming a $500,000 household income. Assuming two spouses both making 250,001st, analysis is going to be all the income is w two. And the second analysis is going to be all the income is 1099.

So we did a separate video fully breaking down $500,000 income. How to estimate your federal tax. So we’re just going to assume our federal tax is 113,441. Our state tax, again, Pennsylvania 3.7. Really, the big differences between w two and 1099 come in your Social Security and your Medicare tax.

So for w two, half of your Social Security tax is going to be withheld and paid for by your employer. And as well as half of your Medicare tax is also going to be withheld and paid for by your employer.

So this estimate, again, we have a $500,000 adjusted gross income. And then after the standard deduction 474, after we take out our federal tax, our state tax, our local tax, half of our Social Security tax, half of our Medicare tax, we have our net take home, assuming both maxing out our Roth 401 KS, our net monthly income of 22 22,000, and our total estimated tax paid of 160.

Great. So this is the analysis we did for same income but strictly 1099. We’re going to assume that spouse one. Has 250 of income, they take off half their standard deduction. Nothing changes from a federal, state and local tax standpoint.

Only changes. You don’t have an employer to pay half of your Social Security tax and half of your Medicare tax. So both sides of that tax are on the employee. So higher Social Security tax, higher Medicare tax for 1099 employees, and same exact analysis for spouse two.

So our total tax if both spouses are 1099 is about 185 and the total tax from our W two analysis was 160. So a $25,000 tax savings if they are W two as opposed to 1099. Ben, thanks for providing that detailed analysis.

So a couple of considerations between a W two and 1099. Obviously on a high level, if you’re W two, you’re going to pay $25,000 less in taxes assuming no financial planning is put into place. This is simply because your employer is paying half of the Medicare and half of the Social Security tax for both spouses, those add up to be $25,000.

However, if you’re a W two employee, there’s a big upside in taxes that you pay being less than 1099. However, you are constricted to whatever retirement plans that your employer provides for you. So for example, if your employer provides a 401K, they only provide the 3%.

Matching the plan may be top heavy. If it’s not top heavy, then you can put away 20,500 into a 401K. Or if you’re above the age of 50, you can put up to 27,000 per year in. But you can’t reach that four one five C limit, which is a total of 61,000.

If you’re a 1099 employee, there are several things you can do. You can set up your own four hundred and one K K. So you can set up your own LLC, create your own entity. You can then set up your own four hundred and one K and put up to 61,000 per year.

So for example, 20,500 versus 61,000, that’s a 40,500 per year difference. If that’s all being deferred. At, let’s just say hypothetically about a 30% tax bracket. That’s a $12,000 per year savings per spouse.

So now our $25,000 that we lost from a tax perspective if we just were 1099 versus W Two, we now gain that exact amount back if we create a 401K for each spouse through the 1099 status and then creating an LLC so alone puts us at a break even.

However, on top of the higher 401K contribution as a 1099 employee, you can also file what’s called an S Corporation. And we did a video just on the S Corporation. But S Corporation allows you to decide what salary that you take and then what’s distributed out.

And when you distribute money out of an S Corporation, you do not pay Social Security tax, medicare tax or local taxes on that. So there could be some additional tax savings if you’re a 1099. So in general, a W Two is better than a tax from a tax perspective than 1099 because the employer takes on the load of the Medicare and Social Security tax.

However, if the right plan is placed is put into place for a 1099, you do have the flexibility to create your own retirement plan with a higher contribution limit, 401K, potentially even a cash balance plan on top of the 401K.

Then you can also file what’s called an S Corporation to allow yourself for more tax minimization strategies. Which one is better? That’s based upon an individualized analysis for you what your cash flow will allow from a retirement savings perspective.

And this is really an individual to individual basis. And we welcome your questions and are happy to analyze this for you specifically.

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