I am often asked whether it is better to take a job as an employee or a job as an independent contractor or some other version of being self-employed. The short answer is “it depends.” The best answer may be “both.” Let me explain.
Upsides of an Employee Job
There are a few significant benefits of an employee job.
An employee is paid on a W-2 Form. Her taxes are relatively simple to file. Her employer pays the employer half of payroll taxes (Social Security on the first $118K of earnings, and Medicare taxes on all earnings.)
Her employer may also offer some sweet benefits like a 401(k) with or without a match, some portion of the premiums on health insurance, and maybe even some portion of the premiums on a group disability or life insurance policy. To the right family, these sorts of benefits can be very valuable.
Downsides of Being an Employee
There are two significant downsides of being an employee.
Unreimbursed Business Expenses
The first is that it is harder to deduct unreimbursed business expenses. These have to be deducted on Schedule A and are subject to a floor of 2% of your income. For a physician earning (technically your Adjusted Gross Income, or Form 1040 line 38) $200K a year, that means the first $4K of unreimbursed business expenses are not deductible at all. That sucks.
Not So Sweet Benefits
The second downside is that you are stuck with whatever benefits (especially retirement plans) your employer sees fit to offer you. If the maximum contribution is low, or there is no match, or the expenses are high, or the investment options are bad, well, you’re stuck with it. If your health insurance is crappy, you’re welcome to go buy a plan on the open market, but if the employer is paying the premiums, it’s usually a take it or leave it situation. Same with other employer-offered insurance.
Downsides of Self-Employment
More Complex Taxes
An independent contractor is paid on a 1099 Form. Her taxes are a bit more complex because she is both the employee and the employer. So she must pay both halves of the payroll taxes, although the employer half is tax-deductible.
No Automatic Benefits
She also gets no benefits except what she is willing to purchase for herself. Since she is just one person, she gets no benefits from an economy of scale when it comes to benefits (including malpractice insurance.) If she wants group disability or life insurance, she will need to get it from her specialty society.
Upsides of Being an Independent Contractor
Her work-related expenses are 100% deductible on Schedule C. Work-related expenses that go on Schedule C are far better than those that go on Schedule A because there is no floor.
She also gets to deduct her health insurance premiums, HSA contributions, and retirement plan contributions, which are all above the line deductions.
Choosing Your Own Benefits
Best of all, you get to choose your health insurance plan, your HSA, your 401(k), and if desired, your personal defined benefit plan.
Which Job Should You Take?
So, if you find yourself comparing an employee job to an independent contractor job, and you like both equally but are unsure which one pays more, it is best to try to do an apples to apples comparison.
First, take the employee job’s salary and add to it the value of any benefits that you actually think are valuable.
Definitely consider any available
- 401(k) match,
- HSA contributions,
- paid CME or vacation,
- and any premium assistance on your insurance policies such as malpractice, health, disability, and life.
Then add in an amount equal to the non-deductible portion of the employer’s half of your payroll taxes.
For Social Security, that is 6.2% * (1- your marginal tax rate) * $118,000.
For Medicare, that is 1.45% * (1- your marginal tax rate) * your entire salary + 0.9% * (1- your marginal tax rate) * (your salary – $200K or $250K if married).
Then take what you would be paid as an independent contractor and subtract the value of the deduction on everything you could deduct that you would not be able to deduct as an employee.
This might include the cost of
- CME expenses,
- the employer half of payroll taxes,
- health insurance premiums,
- HSA contributions etc.
- If the employer-offered retirement plan is crappy, you can also assign a dollar figure to the ability to choose your own.
Now, compare the two values. If one is obviously dramatically superior to the other, you’re done (or at least can use that in ongoing negotiations.) If not, then choose the job based on other factors.
As a general rule, for a physician with an income near the median physician income in the $200-225K range, I would estimate that a typical independent contractor job ought to pay about 10% more in order to be equal to the typical employee job. But that rule of thumb is worth about what you paid for it as there is so much variation out there.
The Best of Both Worlds
Perhaps the best of both worlds is to get some of your income as an employee and some of your income as an independent contractor. That way you can write off all your work expenses that are required for your independent contractor job (but are used for both jobs — like CME, uniforms, licensing fees, DEA fees, specialty society dues, etc) against your 1099 income. This way also lets you have your employer provide your benefits and at least the employer portion of the Social Security taxes, which are the lion’s share of the payroll taxes for a doctor with a median physician income. Another bonus of having two jobs is you may get two 401(k)s as well, allowing you to protect more of your hard-earned money from both Uncle Sam and any potential future creditors.
A Note On Partnerships
Many doctors, including me, are members of a partnership, which is often formed into an LLC, and are paid on Schedule K-1/Form 1065. This has a lot of the benefits of being an independent contractor (lots of easily taken deductions) with a few of the benefits and downsides of being an employee. For example, you may get an economy of scale when negotiating benefits. However, you are probably also subject to the rules of your partnership 401(k) and other retirement plans.
What do you think? Are you paid on a W-2, 1099, K-1 or all of the above? What do you like about it, not like about it? What would you recommend to other physicians? Comment below!