“Death and Taxes” are said to be the only certainty in this world. This idiom holds true for all of us but at this time of year, the taxes part has our undivided attention.
Filing taxes is intimidating enough but in the Contract or Consulting Engineering world where one can be categorized as a W-2 or 1099 status; there are tax and withholding complexities that can confuse even the savviest of us.
Given the project-based nature of product development (especially in high tech areas such as Silicon Valley or Southern California), it is common for Mechanical Engineers, Electrical Engineers, Software Engineers to take on consulting or contract projects. In fact, many large technology companies will mandate that a percentage of their workforce and/or projects be staffed with contingent engineering resources. This enables them to scale up or down rapidly and to assign labor cost directly to projects, not as general overhead.
The problem or confusion can arise depending on how the engineering resources are procured. There are a number of ways a company can go:
- The company can engage the engineers directly as contractors or consultants
- They can use a staffing agency to be the “employer of record” to handle all the compliance requirements
- They can outsource the project to an “engineering consulting” company (which in turn engages the engineers as contractors or consultants).
For the engineers who are recruited for these projects, they can be categorized as W-2 employees or 1099 independent consultants (sometimes referred to as a “Corp-to-Corp” structure).
Regardless of the category, there are a number of tax implications that contract engineers need to be aware of. We will discuss the tax treatment of a W-2 employee and that of a 1099 independent consultant.
When a company uses a staffing agency to engage engineering resources, typically their intention is to have contract engineers be categorized as W-2 employees. This provides a layer of protection for the company since the staffing agency is the “employer of record”. The staffing company will handle all state and federal employment compliance requirements:
- All state and federal income tax withholdings
- Disability and unemployment insurance
- Workers’ compensation insurance and liability insurance
The W-2 employee (the contract engineer in this case) only has to be concerned with claiming the correct number of dependents so appropriate amounts can be withheld. When the project or assignment is completed, the W2 employee can file for unemployment benefits. The W-2 employee can also claim unreimbursed business expense as itemized deductions on their tax return. The advantage of this treatment is the simplicity of the tax status, simplicity of documentation and record keeping. Other than the short term nature of projects, contract engineers are treated as standard employees from a tax standpoint.
Things are not as simple for contract engineers who work as 1099 independent contractors. In this treatment the contract engineer is not an employee of any company (neither the staffing agency nor the end client company), but is treated as a business entity providing services to the end client. Many contract engineers believe that operating in this way presents the advantages of writing off many of their business related expenses against their income. Although this is true, careful accounting must be done to ensure that the perceived advantages can be realized.
The main reason companies engage engineers as 1099 independent consultants is to clearly establish a business to business relationship and not employer and employee relationship. The main advantage to the company is it will not be viewed as an employer, it will not be required to handle payroll withholdings, or be required to provide benefits typically afforded to employees.
The slippery slope.
As a business entity the 1099 contract engineer is treated as both the employer and the employee by the IRS. Often 1099 contract engineers do not realize that they now have tax responsibility as an employer to go along with paying income tax as an employee. The IRS will require payment for both the employer and the employee portion of FICA tax (Federal Insurance Contribution Act – covering Social Security and Medicare). Many times, 1099 contract engineers will not realize this and miscalculate their tax liability. The list below will help with tax liability estimation:
- 6.2% Employee Social Security
- 6.2% Employer Social Security
- 1.45% Employee Medicare
- 1.45% Employer Medicare
- 10% State Income Tax
- 28% Federal Income Tax
In all, 1099 contract employees should set aside about 53% of their income for taxes. They are required to file and pay estimated taxes quarterly. In addition, since they contributed nothing into the unemployment insurance pool for the duration that they worked as a 1099 consultant, they may not automatically receive unemployment benefits if they choose to file. Last but not least, 1099 contract employees are required to have their own liability insurance (another cost to consider).
As stated earlier, it is common for many technology companies to manage their engineering product development efforts in terms of well-defined, finite projects. This drives demand for contractors and consultants in the areas of Mechanical Engineers, Electrical Engineers, Manufacturing Engineers, and Software Engineers.
It is also common for engineers to work both as a W-2 employee and a 1099 independent contractor, often times in the same tax year. If this is the case, the engineer must be even more diligent in understanding the tax implications associated with how they were classified by the client company or agency. Being aware of one’s tax situation can help avoid unpleasant surprises from the IRS in the form of fees, penalties, and interest charges.
If your company wants to hire engineering talents but needs assistance with the employer tax responsibilities, OR, if you are an engineer who’s looking for your next assignment either as a W-2 employee or 1099 consultant, contact SoloPoint Solutions today! Our helpful staffing experts are available to assist you!