Contractor LLC vs. Full Time Employment
Hi WSO,
I am recently approaching the end of a trial period as an associate, and have been offered an opportunity to continue as a contractor or convert to a full-time employee. As a contractor, I would be able to setup a single member LLC and take advantage of favorable tax laws, and I think it's a net positive in that regard. However, I'm not sure if or how this could impact my upside here long-term, and worry I may not be considering all factors. If anyone here has gone through this experience and could share some knowledge that would be appreciated.
Thanks.
Generally, being a contractor = consultant, and typically non-exclusivity is implied (can be made exclusive but really blurs the point). So, I would inquire to see if they mean a different working relationship in one mode or another. Technically, a contractor has a very different work relationship as they are your client, not your boss. In practice, this may not always look this way.
Also, being a 1099 contractor, you will not eligible for any benefits, 401Ks or anything like that. Further, you are assumed on the hook for your expenses but they could of course be billed back. You do get to pay self-employment tax since they aren't paying their 50%. So the contractor prices should be increased at least by the difference in the higher taxes and loss of benefits. So, if you would get $100k as an employee, the equivalent contractor pay should be $120k+ (really more, as their should be some premium for risk).
I'm guessing this may be a small firm, no large firm would do this, as they could get flagged for violating IRS rules on independent contractors. A small firm could legit keep someone this way and got trigger any issues.
Personally, I'd tread carefully, talk to a lawyer and accountant. Generally, you are better off as W2 employee unless you get some freedom or other benefit YOU want for remaining 1099.
Thanks for the insight. There's some additional questions I need to get answers on before making the decision. Would you mind explaining what IRS rules could be violated for keeping employees as contractors?
It is a small shop, but I got the impression this choice was offered to the employees to provide flexibility. Yes, I'd be giving up on health insurance and 401K plans, but I'm at an earlier stage of my career where I can buy health insurance and open a SEP IRA, and the tax deductions would ultimately leave me better off. At the end of the day it might be a hassle and not worth the additional effort for a few grand in savings.
I don't think base comp would change although bonus would likely be higher. However, I'm more concerned about how being a contractor could affect my eligibility for co-investing and carried interest participation down the road.
The IRS rules are really the issue for the employer, but essentially, if you are 1099 then you are supposed to be independent. If it is really a 'job' then they can get fined for failure to pay taxes, etc. Just google 'tests for independent contractor status' or something like that.
Overall, I'd want to talk to attorney and tax accountant in your area. As you are aware and others have said, there are potential tax savings. I've done consulting work in the past and can say that there are some cool features for those filing schedule Cs, or even doing the whole S-corp deal. Most presume you are paying your 'expenses' directly either way. So, for it to work, your pay rate has to be normal salary + reimbursement of expenses to make it have any chance of making sense. If that is the case, then it may make sense. If it is literally $100k either w2 or 1099 (or whatever), then you may be making a mistake, but it's really in a weed of details beyond what anyone here can answer.
The other part to consider is that in order to get those tax savings, you will likely need to pay an accountant a lot more and even need to have a payroll service (to pay yourself a so called 'reasonable salary'). These are real costs so be sure to factor into the overall decision.
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