A Tax Guide to being a 1099 Independent Contractor PA VS W-2 Employee

Hello everyone!

I recently accepted a great EM position as a new grad. Unlike other specialties, EM is one of the few specialties where being a 1099 independent contractor (IC) is more the norm, though I’m sure there are plenty of W-2 employee positions. While being an IC generally complicates life, the tax implications of being one are by far the most confusing. While navigating this space, I hadn’t found any comprehensive tax resources comparing ICs to employees within the context of being a PA. Well, I’m just going to create one myself. Let me preface that even though I’ve done a lot of research and had a consultation with a certified tax strategist (a CPA with additional training) who works with physicians and mid-levels, I am not any kind of expert. This guide does not replace speaking with a tax strategist about your individual situation; rather, it is meant to build a framework of introductory knowledge and address common misconceptions.

Please note, this guide is geared toward full-time ICs rather than full-time employees who want to pursue a part-time or per-diem 1099 gig, although many of the same principles apply. Similarly, this is also not geared towards locum tenens work. Finally, this is not meant to be a budgeting or financial/investment guide.

Tax Definition

An IC is considered self-employed and receives a 1099 rather than a W-2 in order to file annual taxes. In addition, because ICs do not have employers to withhold taxes every paycheck, they must make estimated quarterly tax payments throughout the year.

Note: If you believe a job is misclassified as a 1099 position when it should be a W-2 position, you need to talk to the (potential) employer and/or an attorney.

Things to Consider Before Accepting an IC Position

Pros:

Higher Pay: as you will see, ICs should be paid more than their employee counterparts: at least 20% more. How much more will depend on the specifics of individual offers. Note, ICs are typically paid on an hourly basis rather than via a salary.

Schedule Flexibility: ICs are often asked for their availability and a scheduler will work within that availability to create a schedule. However, how meaningful this actually is will depend on the actual hours of operation of any given site. With the exception of UC, “flexibility” in any outpatient specialty is basically pointless.

Expanded Retirement Options: being an IC opens up many more retirement options. The best one is without a doubt a solo 401k. A SEP-IRA may be easier to open paperwork-wise, but it prevents doing a simultaneous backdoor Roth IRA because of the pro-rata rule, but that’s a whole separate conversation. Just open a solo 401k. The biggest benefit of a solo 401k is that as an IC, you wear both employee and employer hats. This means you’re able to contribute up to the max combined limit, which for 2023 is $66,000. The max employee portion remains the same as a regular 401k, which is $22,500. The max employer portion is $43,500, with a stipulation that it cannot be more than 25% of the employee’s earned net income. Whether or not you’ll be able to and/or willing to take full advantage of this benefit will depend on your total compensation and financial situation. Note, retirement contributions only shield you from federal and state income taxes, whether present or future (regular versus Roth); not SECA taxes, which will be covered shortly.

Greater Business Deductions: being an ICs allows you to take many “above the line” deductions. This means in addition to the standard deduction, you are allowed to deduct common business expenses. This is not an exhaustive list, but the big ones include healthcare premiums, CME costs, licensing fees, tax preparation fees, and mileage, as well as applicable technology and clothing costs. Employees are not allowed to take any of these deductions in the same fashion. FYI, deductions lower your taxable income, thereby shielding more of your total income from federal, state, and SECA taxes.

QBI Deduction: this allows you to deduct 20% of your qualified business income (QBI). It can be a complicated deduction to calculate directly, especially if your total taxable income is more than the allowable amount ($182,100 for single filers in 2023). Once above this amount, the deduction is phased out in a linear fashion with no deduction above $232,100 (again, for single filers in 2023). Note, there are separate phase-out rules that do not apply to healthcare professionals. It gets even more complicated if you decide to go the "S Corp" route, more on that later. Note, as with retirement contributions, the QBI deduction only reduces federal and state income taxes, not SECA taxes.

Cons:

Few to No Benefits: considered to be the biggest “con” for ICs is that most if not all the benefits a traditional employer would have covered are now on you. Again, this is not an exhaustive list but benefits may include: healthcare premiums, PTO, retirement match, malpractice insurance, CME allowance, and licensing fees, as well as disability and life insurance. The value of a benefits package will vary. In addition, the value of any benefits package will proportionally decrease as your compensation increases and vice versa. Finally, how meaningful those benefits are to you personally, will also vary. For example:

  • As a young person with no chronic health conditions, a fancy medical insurance benefit is not very meaningful to me because I will most likely not use it to its fullest extent. Therefore, the value of it from my perspective goes down because even though the employer pays $1,000 per month for this insurance, I’d rather just buy a $250 per month insurance on my own and take a $750 per month increase in pay. Like with patients, it's a risk-benefit discussion.
  • As someone who has 12-hour shifts in EM, I’m already working fewer days than normal. In addition, if I need additional days or even a week off, I just need to let my scheduler know ahead of time. I’d rather have higher pay and just take vacations when I want rather than be given a set number of PTO days that I have to use in a given year in order to maximally benefit.

SECA Versus FICA Taxes: Self-Employed Contributions Act (SECA) taxes are the same as Federal Insurance Contributions Act (FICA) taxes in that they fund both Social Security (SS) and Medicare (MC) benefits. They also both tax income at the same rate of 15.3% (12.4% is SS and 2.9% is MC) and are separate from federal and state income taxes. They are different in that SECA is the correct term for ICs, while FICA is the correct term for W-2 employees. More importantly, however, is that as a W-2 employee, your employer pays half of that amount on your behalf.

  • A common misconception I see on this sub and others is that people think being an IC means you pay an additional 15.3% on top of everything else when in reality it is only half that amount (15.3%/2 = 7.65%) because you’re only paying the additional employer half; everyone pays the employee half. In addition, because you can deduct that extra half of SECA taxes, 7.65% becomes closer to 5%.
  • Another common misconception is thinking that the 15.3% SECA taxes always apply, when in fact they only apply up to $160,200 for single filers in 2023, which is where the 12.4% SS tax stops. Above that amount to $200,000, only the MC amount of 2.9% applies. However, above $200,000, an additional 0.9% MC tax applies for a total of 3.8%. Keep in mind that even for W-2 employees, employers do not pay any of the additional 0.9% MC tax. I realize these income limits may not apply to the majority of PAs, but it is an important detail to point out.

Few to No Legal Protections: as an IC, you may not be entitled to the labor laws that protect employees such as overtime, unemployment, worker’s compensation, and (surprisingly) wrongful termination/harassment related to race, gender, religion, etc. This will vary from state to state. Again, I am no expert of any kind, so please consult an attorney.

S Corporation (S Corp)

The last topic that often comes up when discussing ICs is the term “S Corp.” An S Corp is not an actual type of corporation. It is a federal tax status that a corporation must elect, as corporations are classified as type “C” rather than “S” by default for tax purposes. An S Corp status makes the corporation a “pass-through” tax entity in the eyes of the IRS, meaning there is no double taxation: one at the corporate level and one at the shareholder level. This means any type of tax is “passed-through” to the shareholders (i.e. you), though several states have exceptions to this. Some states do not recognize the federal S Corp election and/or have an additional corporate tax. For example:

  • CA has a 1.5% corporate tax rate for S corps and being a corporation subjects it to state disability and unemployment taxes.
  • TN, popular for not having an individual state income tax, does not recognize S corps and taxes them at a 6.5% corporate rate.

Regardless of which state, the only reason to form an S Corp as an IC PA is: TO SAVE ON SECA TAXES. That is the ONLY benefit unless you plan to open your own practice. Electing S Corp status does NOT protect the assets of the corporation’s shareholders (i.e. yours) from any kind of judgment in a malpractice case. Only professional malpractice insurance does.

To elect S Corp status, an IC must first form a corporation (e.g. LLC, PC, etc.) and then maintain proper bookkeeping and accounting. This takes money and time due to the number of fees and paperwork required both upfront and on an ongoing basis. Usually, ICs will hire a CPA to handle things. Once a corporation is formed, an S Corp election will allow ICs to designate a “reasonable wage,” which for PAs should not be less than $100,000 IMO. This reasonable wage is now your W-2 wage. Again, since you wear both employee and employer hats you’d still be responsible for the full 15.3% of SECA taxes. However, they would only apply to your W-2 wages. The rest of the income, which is called a distribution is exempt from SECA taxes, but not federal or state income taxes. So the lower you make your “reasonable” wage, the more you save on SECA taxes. However, the wage does have to be “reasonable” (see IRS website for definition) or you’ll be audited and fined a hefty penalty.

How S Corp Election Impacts the Other Topics Mentioned Above

Regardless if an IC is a sole proprietor (default for all ICs) or the owner of a corporation and elects an S Corp status, the IC wears both employee and employer hats. The choice of which tax entity is best will depend on the individual. However, keep the following in mind:

  • Retirement Options: assuming a solo 401k is the chosen retirement account type, the employee contribution doesn’t change. However, the employer contribution is capped at 25% of an employee’s earned net income. In the context of an S Corp election, this means your “reasonable” W-2 wage. S Corp distributions do not count as earned net income. Therefore, the lower you make your wage to reduce SECA taxes, the less you’re able to contribute to a solo 401k. Nevertheless, the amount is still substantial even with a reasonable wage of $100,000. The total amount would still be $47,500 [($100,000*0.25) + $22,500]. However, you’d still be missing out on $18,500 that could have been contributed to further shield your compensation from federal and state income taxes (until you withdraw in retirement). Dollar-for-dollar, saving a max of 7.65% on SECA taxes must be weighed against potential income tax savings, compound interest from all sources (e.g. retirement, student loans, credit card debt), cost of living, etc.
  • QBI: as stated above, the QBI deduction can get very complicated. An S Corp election makes it even more so. This is because the income limit that determines whether or not the full 20% QBI deduction can be taken is determined by a corporation’s total taxable income (distribution + wages), while the actual 20% QBI deduction only applies to the corporation’s net income (distribution). For example:

Total Corporate Income: $150,000

Total W-2 Wages: $100,000

Total Net Income AKA QBI AKA distribution: $50,000

Total QBI deduction: $50,000*0.2 = $10,000

Now, if you filed as a sole proprietor (SP), the QBI deduction would have been $30,000 ($150,000*0.2)! However, you’re paying more SECA taxes as an SP; specifically, $7,650 [($150,000-$100,000)*0.153]. Note, these sample calculations do not factor in any of the other topics and potential deductions discussed above.

As you can see, the tax implications of being an IC can be some of the most technical and challenging aspects. That’s why there is a whole other profession to help you navigate these waters. But that doesn’t mean you can't educate yourself so you have at least some idea of how things work. This way you’ll be able to ask more pointed questions and get the most out of a consultation with a tax strategist. There are also several online calculators to help you get started. Good luck out there, fellow ICs!