By FlexMedStaff
Unless we all become real estate moguls like Donald Trump, you should expect to pay taxes. As a wise man once said, “the only guarantee in life is death and taxes.” There are many legal tax loopholes that real estate professionals can take advantage of to reduce their tax burden significantly. In some instances, these professionals can avoid paying taxes altogether. This is not the case for most medical practitioners. Many of us do not devote enough of our career to real estate investing to take advantage of all these tax loopholes. Thus, we should expect to pay our share of taxes. What defines our “share” depends on how you are paid, tax deductions, pre-tax investments, and other business adventures. This article focuses on the differences between 1099 and W2 income.
Pre-tax vs Post-tax:
W2 and 1099 refer to tax filing forms. An employer provides a W2 form to an employee on their payroll. A 1099 form is given to an independent contractor for specific services rendered.
The first thing to understand is the difference in how the money looks when it hits your bank account. When paid as a W2, this is “post-tax” money because the taxes are removed before the money is deposited into your account. Whereas those paid as 1099 will have “pre-tax” money deposited into their account. W2 employees are only required to file taxes once per year.
Taxes:
There are three major components to paying taxes. This includes self-employment tax, federal taxes, and state taxes. When you receive a W2 payment, these taxes are already taken out of your paycheck. This is why we use the term “post-tax” money when we refer to W2. However, taxes are not taken out of 1099 payments.
It is essential to understand how “self-employment tax” is dealt with as a W2 and 1099. The self-employment tax rate is 15.3%, which includes social security (12.4%) and Medicare (2.9%). As an employee that receives a W2, the employer pays 1/2 of that 15.3%, and the employee pays the other half. When an independent contractor has 1099 status, that individual is responsible for paying the complete 15.3% themself. Interestingly, the government loses its appetite to enforce a self-employment tax once an individual makes over $142,800 (based on 2021). Taxable income over $142,800 is taxed only on the Medicare portion (2.9%) and not the total self-employment tax of 15.3%.
Deductions:
Some standard tax deductions are relevant to those that make W2 and 1099. Those deductions include childcare, marital status, mortgage interest, etc.
Unlike W2, those with 1099 can “write off” their business expenses related to providing professional services. These business deductions include but are not limited to travel, meals, internet, phone, home office, vehicle, CME credits, and licensing fees. 1099 practitioners can also deduct the expense of health insurance and their malpractice policy.
1099, pre-tax money can be used to help start and run a business created by practitioners. If W2 practitioners were to do this, it would be post-tax money to pay for these endeavors.
With 1099 income, a practitioner can potentially take advantage of the “pass-thru” deduction. This was implemented for small businesses but can be applied to sole proprietors. This tax deduction is based on “net taxable income,” which is the total amount that the state and feds tax after deductions and investments are taken into account. The criteria depend on the practitioner’s marital status but can lead to a 20% tax deduction on net taxable income. This can save a significant amount on taxes. For singles, the pass-thru deduction can lead to a 20% tax deduction on up to $164,900 taxable income. Married couples can get a 20% tax deduction on $329,800 taxable income. An accountant should run these numbers for you as some tricky math is involved in some cases.
Pre-tax Retirement Accounts:
There are also differences in pre-tax retirement investments as a 1099 and W2. A full-time W2 employee generally gets access to pre-tax investment funds such as 401k, 403b, 457, and 529. Many employers will have a matching program for their 401k accounts, which 1099 independent contractors will not have access to. On the other hand, a 1099 practitioner can fund both portions of a 401k with pre-tax money, the employee ($20,500) and employer contribution ($61,000). These numbers are based on the 2022 tax year and are expected to increase over time.
Another pre-tax retirement fund for those paid as a 1099 includes a Defined Benefits Plan. This is also known as a Cash Balance Plan. In simplest terms, this type of retirement fund is like a 401k on steroids. It’s the government’s way of allowing individuals to fund their own pension plans. Over many years, a practitioner can invest approximately $2.5 million pre-tax into these retirement funds. The annual contribution is based on the individual’s current age and expected retirement age. These retirement plans must be configured and reviewed by an actuary and a CPA.
S-corporation:
Another item available to 1099 independent contractors, not W2 employees, is the ability to have an S Corporation (s-corp). Individuals with their own LLC or PLLC can declare S-corp status on their taxes. Like a small business, an s-corp allows the practitioner to pay themselves a salary and then “bonus” on the leftover money. A certified accountant should discuss the advantages and disadvantages of an S-corp.
Net Taxable Income:
Your net taxable Income is the amount of money the states and feds will tax you based on. To calculate your net taxable income, you must subtract your expenses, tax deductions, and pre-tax retirement contributions from the gross income. Once you arrive at your net taxable income, your effective tax rate can determine how much you owe in taxes.
Conclusion:
Please recognize that the above material is not meant to be taken seriously without having it reviewed with a certified accountant or tax strategist. The content here only introduces how 1099 and W2 income is dealt with and how to determine net taxable income. Each practitioner’s situation is different, and a professional should design an individualized tax strategy.
This table briefly summarizes how items are paid for if you have sole income from W2 or 1099. If you have W2 and 1099 income, these items might be handled differently, so contact a professional to discuss.
| W2 | 1099 | |
| Income | Post-tax | Pre-tax |
| Standard Deductions (i.e., marital, mortgage, childcare) | Calculated Pre-tax | Calculated Pre-tax |
| Business Expenses (i.e., CME, travel, home office, etc.) | Paid for with post-tax money. | Paid for with pre-tax money. |
| Pass-thru Deduction | Not available. | Available if you meet the criteria. |
| Health Insurance | Paid for by the employer and pre-tax dollars. | Paid for with pre-tax dollars. |
| Business investments | Paid for with pos-tax dollars | Paid for with pre-tax dollars |
| 401K Matching | Invest with pretax money, then matched by the employer. | Must set up self-funded 401k. |
| Self-funded 401k | Not available to those that do only W2. | Fund with pretax money for employee and employer contribution portions. |
| Defined Benefits Plan | Not available to those that do only W2. | Funded with pretax dollars. |
| S-corp declaration | Not available to those that do only W2. | Yes, available. |
