22 May 5 Differences Between Employees and Contractors That Every Physician Should Know
When you work for someone else they classify you as either an employee or contractor. This distinction has legal and tax consequences for you and the person/company you’re working for. The classification of a worker as an employee or contractor shifts costs between the worker and company so the two parties have competing interests.
The IRS has developed a 20-part test that it breaks down into three categories –
- Type of Relationship
In practice, I’ve seen medical groups and doctors give the choice to a new doctor over whether to be treated as an employee or contractor and I’ve seen workers mis-classified to the employer’s benefit.
It’s important for you to understand when you’re at a disadvantage by being classified one way the other. So here are the 5 differences between an employee and contractor that every physician should know –
1. Payroll Taxes
Your wages are subject to a 12.4% Social Security tax on the first $132,900 (for 2019) and a 2.9% Medicare tax. You split this tax with your employer where they pay half and you pay half. Your employer withholds your half from your paycheck and is responsible for remitting it to the IRS.
You’re responsible for the entire 15.3% on what they pay you minus any of your expenses. This is called the Self-employment Tax and is equivalent to the tax paid on your wages.
So if you’re earning $132,900 and your employer mis-classifies you as a contractor, they shifted $10,166.85 of taxes to you. While this seems like a lot, it’s not the only factor to consider. There are other factors that can make it better to be a contractor.
2. Estimated Taxes
Your employer withholds federal and state income tax from your paycheck and pays it to the government for you. The amount of the withholding is determined by tables published by the IRS and states and are usually very accurate.
You’re responsible for paying in your federal and state income taxes during the year. There are two main considerations I address with my clients –
- Estimated tax penalty
- Avoiding a large tax bill
The IRS requires you to not only pay your taxes in full by April 15th of the following year, they want you to pay the money in during the tax year or face a penalty.
You need to pay at least 90% of the current year tax or 100% (110% if you make over $150,000) of the prior year tax in four equal payments due April 15th, June 15th, September 15th, and January 15th.
It’s surprising how difficult it can be to set enough money aside during the year to have paid your taxes in full. I often recommend setting aside a certain percentage from each payment to cover estimated taxes.
3. Tax Reporting
Your employer will give a Form W-2 by the end of January for the previous year. You use this form to report your taxable wages and federal and state income tax withholding on your individual tax return, Form 1040. Very easy.
You will receive a Form 1099-MISC showing the total of what they paid you. You are then responsible for reporting this income on Schedule C of Form 1040.
4. Expense Deductions
Starting in 2018, employees are no longer allowed to deduct “employee business expenses”. Prior to 2018, the deduction was limited by your AGI and whether you itemized or not so it wasn’t always a benefit anyway.
This just means you need to get reimbursed by your employer for your out-of-pocket expenses.
You’re able to deduct any and all “ordinary and necessary” business expenses on Schedule C related to your work. This is better than an employee if there’s no possibility of reimbursement.
It’s always better to get reimbursed than to be able to deduct an expense though.
5. Retirement Plan Options
You’re essentially limited to what your employer offers. As a doctor you likely make too much money to contribute to an IRA but a back-door Roth IRA could be possible.
But your employer could be contributing to your retirement in addition to your salary.
You have more options for retirement plans and could potentially put more money away. This requires more legwork on your part though.
If you’re working somewhere as a contractor for the first time it’s important to understand these 5 key differences. I’ve seen many people surprised at how much they owe after their first year of contract work.
It’s also very important to avoid being improperly classified to your detriment. If you know the factors and understand how you’re being harmed you’re in a better position to negotiate.