W2 Employee vs Independent Contractor

Welcome back associates. My name is Drew Phillips. I'm a CPA and CFO advisor here at Practice cfo. Working with dentists and other privately owned medical practices over the years has been a pleasure and a true passion for me, and today I'm excited to chat with you all about the differences between a W2 employee and an independent contractor. My goal for you all in this module is to gain a better context and clarity around the key differences between a W2 employee and an independent contractor and how those differences affect your life as an associate. Let's get started by jumping into the key benefits for the different Associate classifications and later we will discuss the best strategy for you during your pursuit of employment based on your goals and ambitions. First up, we have the benefits of being classified as a W2 employee. It's also helpful to note that each benefit is a corresponding con of the other. Our first Pro as a W2 employee is the potential eligibility to participate in employer sponsored benefits. I say potential because there are some employer sponsored benefits that also have a minimum hours requirement. The hours requirement is unique to the employer and the benefit being offered, so it's helpful to get a better understanding of what those employee benefits are before being offered and that way you can check the specific eligibility requirements during your interview process. Equally as important is to have a strong understanding of how many hours the practice you're applying is offering to you and if that's enough to meet the eligibility requirements. Let's look at a few benefit programs that typically draw the most excitement and attention from associates. A fan favorite are 401 plans, and Wes Reed, my colleague, will go over 401 plans in depth in fuel cell 3. But there are a few important points to note from the perspective of a W2 associate. 1. Understanding what kind of match program the practice offers to their 401 participants. There are two types of match non elective contributions and matching contributions. Under a non elective match, your employer will contribute 3% of your W2 salary regardless of whether or not you you make any personal contributions to the plan. As an employee, this match style is preferred, but it's also a little less common. And secondly, under a matching contribution, your employer will match your personal contributions dollar for dollar up to 3% of your salary. In other words, if you contribute 5% of your W2 salary to the plan, your employer will contribute 4% of your W2 salary. Under these arrangements, at a minimum, I recommend you contribute 3% because where else in the world are you going to Go get a 100% risk free rate of return on your investment. It's pretty cool. It's not to mention there's some pretty cool tax benefits that come along with those contributions. Eligibility for 401k plans usually require the employee to have both worked at the practice for a year and a minimum of 1000 hours per year. Some employers will have more relaxed eligibility requirements, but typically this is what you'll find. As a quick reference, 1000 hours is usually met if you work 8 hours a day, 2 1/2 days a week, or just a little over 20 hours per week. Another potential benefit as a W2 employee is an employer sponsored or employer subsidized health insurance plan. Health insurance is a critical thing to have in our country and it's not cheap, which makes this a great benefit to have whether or not it's in full or if it's partially subsidized. Eligibility for these plans range widely. A few common restrictions that I see are they're only offered to full time employees only to employees in certain job positions, only salaried employees, potentially only employees with higher seniority and the only caveat to the eligibility exclusions is that they have to be employment based and they can't be discriminated against, race, disability, sex or religion. Our next pro for a W2 employee is that there's no accounting or business tax returns required. As a W2 associate, you don't need to maintain your bookkeeping records for business expenses or file a business tax return, saving you time, money and potentially a headache depending on what CPA you're working with. Not of us, of course. Additionally, tax and personal financial planning are much easier as a W2, in part because you have less tax planning opportunities, but also because your payroll provider is computing and making all of your tax withholdings for you each pay period. Those tax withholdings are factoring in personal financial planning Items like your 401k, your section 125 health insurance premium if it's an employer subsidized plan, and most payroll software systems really, they're really not that smart. They're not smart enough to accurately withhold taxes if you have a business income component or but if all of your income is from your W2, it typically does a decent job at computing or withholding and all the required taxes for the year. So if your tax withholdings are taken care of and the money that hits your bank account each pay period is after tax dollars, well, you've solved 25% of the personal financial planning equation, which is to understand what your after tax cash flow is each month. Another significant step in personal financial planning is having a well designed allocation for your after tax dollars and that will maximize your risk adjusted rate of return. And my colleague Paul Lipschis will go into great detail on financial planning and how it can accelerate your way to financial independence as an Associate While we're on the topic of payroll companies, as an associate, you may end up working for two or three offices, maybe more. And while I mentioned earlier that payroll companies do a decent job of calculating and withholding your taxes each pay period, that accuracy goes down incrementally with each additional office that you work. The reason being is that payroll companies are like a horse with blinders. It only knows the income you're making at that office. It doesn't know that you're making an additional 60,000 at office number two or 50,000 office number three. So this payroll company withholds. So effectively this payroll company will hold a lower effective tax rate than you actually will owe at the end of the year. But because when all of those other W2s come into an aggregate, you'll be taxed at higher marginal rates than your payroll company would have taxed you throughout the year, potentially leaving you with a ending taxable liability.

Lastly, if you have multiple W2s and the sum of all of your W2s exceed $250,000 married filing jointly or $200,000 as a single filer, but in isolation they don't exceed these figures, you will owe the Additional Medicare tax of 0.9% for the amount over the figures of $250,000 married filing jointly or $200,000 single. And your employer won't know to withhold this for you. So you can either amend your W4 with your employer to have them withhold the right Additional Medicare tax, or you can make quarterly contribution payments or on your own in the event that you overpay in FICA taxes and you have more than one employer, you can receive a refund when filing your personal tax return at the end of the year. And if you only have one employer, you'll have to get that refund from your employer. As a W2 employee, there isn't a corporate and administrative fee or yearly requirements to maintain things like your statement of information, board meeting minutes, your city or county business licenses, business receipt tracking, and corporate state tax fees. And you know another great benefit of a W2 employee is there's less FICA taxes. And we all love less taxes. And this is one of the major benefits of being a W2 is that you're effectively paying 7.65% less on every dollar of income for your first $132,000 and 1.45% less for wages earned above $132,000. At least in 2020.

When you're only a W2 employee, you don't have to pay your employer portion of the FICA taxes, which is why you capture these savings. Also, just as an FYI, in case you are the curious type, the Social Security portion of FICA taxes, which represents 6.2% of the 7.65% I mentioned earlier, is phased out at 132,000, which is why we saw this small differences at that level.

Another nice benefit of being a W2 employee is when it comes to tax time. Personal tax filings are much, much simpler. And I'm sure most of you during your residency or had a college job, you used a system online like TurboTax or some other assisted online tax filing system. And when all of your income is W2, they make for great tax preparation tools. It's super simple to use. In fact, most of them automatically import your W2 from your employer and the whole process can be completed in less than an hour with your tax refund in your checking account in two weeks or less. Not to mention a lot of cases it's completely free if you have capital gains or itemized deductions, so on and so forth that make their return a little bit more complicated. It can cost a few bucks, but pennies in comparison to a CPA prepare return. But as you become a business owner and you successfully add the critical tenets of wealth to your portfolio, having a highly reputable CPA dental specific CPA in most cases to plan and prepare your tax is an essential element in your global retirement plan. But as an associate in many cases you can get it done with less. Next, let's get into the benefits of being an independent contractor. You're a business owner and honestly that's pretty cool. The tax code was built for business owners and you're now a subscribing member. And as a member you gain access to new fruitful tax deductions. Dentists and dental specialists by nature are professional service providers which come with association dues, insurance requirements, continuing education, all of which cost money and before you were a business owner any it was your sacred after tax money going to pay for these items. But now you're going to get a tax deduction for these expenses or as I like to call it a coupon. A few common Expenses worth noting as an associate business owner are national and state dental association dues. Your malpractice insurance, continuing education.

Travel, typically in conjunction with your continuing education. You have automobile expenses, home office expenses, you have your loops, potentially your scrubs, business meals. And depending on the practice you're associating in, you may be responsible for a portion or all of your lab bills. In the event that this is the structure that you're in, you will also be able to deduct these expenses as well. All these tax saving opportunities add up and they translate into more after tax money for you. And after tax money is what we're all after. And the more of it you have, the more investment opportunities you'll be able to pursue and, and the faster you'll be able to obtain financial independence, which is why we're all here. The vast majority of young associates are going to have a nice student loan bill accompanying them out of school and after residency. And we have a whole section dedicated to student loans and the best way to navigate those for the purposes, but for purposes of our lesson, the key takeaway is that as a business owner, you'll be able to lower your tax bill, which also effectively lowers your monthly income based repayment, which because the amount is based on your taxable income. So in short, lower taxable income equals lower IBR payment, or I should say IDR payment, the various income driven repayment plans that exist out there. As a business owner, not only do you get access to greater tax efficiency, but you also unlock the ability to contribute more money to tax deferred retirement plans. As a W2 employee, if your employer offers you a 401 plan, you have the ability to contribute at most 19,500, which is the limit in 2020. And those are in the form of elective deferrals. Elective deferrals are done through your payroll and reduce your net check each pay period. You'll also get a match component on your contributions from your employer and maybe even a small profit sharing contribution depending on the employer's plan design. So in short, as a W2, you have the ability to save 19,500 in taxes, or I'm sorry, you're allowed to contribute 19,500 to your 401k plan, which ultimately saves you taxes from those contributions because that 19500 will be considered a tax deduction for you. But as a business owner, especially as a business owner, with only you being the staff member as your associate, but also technically a business owner, you can contribute up to $57,000 to your 401k plan without any additional staff costs, a whopping $37,500 more in tax deferred investments, passively growing at 7 to 8% year over year. Putting these things together as a young associate is a powerful combination that will hyper accelerate your path toward financial independence. Not everyone wants to be a practice owner, but if that's something you envision for yourself, being an independent contractor can give you a head start. First, it gives you the advantage of learning how to manage and track business expenses. Second, if you decide to incorporate, we'll chat more on that in a minute. You'll have the benefit of having your corporation already established which you can later use to purchase your future practice. Third, if you incorporate, you'll also get credentialed with insurance companies under your corporate identification number in combination with your National Provider Identification number, which is which will save you a ton of time and headache in the future because you won't need to get re credentialed when you become a practice owner. Additionally, it will save you headache with the IRS because when you credential with insurance is under your Social Security number, which you will if you were a W2 employee and then when you become a corporation in the future you'll potentially get conflicting 1099s that will list your Social Security number instead of your corporate ein, which ultimately will trigger IRS letters to be sent and extensive follow up to clear up reporting errors. A lot of young associates are stoked about growing their skill sets and taking on more advanced treatment and often the best place to do that is in a private practice with tons of new patients, newer equipment and an experienced owner that is on site frequently to help you expand your treatment range. The preferred compensation structure in a private practice typically is to have an associate listed as an independent contractor and the reason why is it reduces the owner's tax burden in the form of FICA taxes. And you'll find that Most of your W2 opportunities are going to come from corporate dentistry or PDS. And I'm sure all of you have heard the great stories about working in corporate and PDS dentistry. That is our module on the differences between W2 and independent contractor. I'm excited for our next module. Stay tuned.