Forming an S Corp vs. Accepting a W-2 Role: Pros and Cons

If you’re exploring a new role, you may be asked to choose between traditional employment and contract work. The most traditional path is regular employment, where you receive a regular W-2 salary with a company in exchange for your services and expertise.

However, if you like the idea of being in business for yourself, you may want to consider setting up an LLC and electing as an S Corp to accept the contract role.

Providing services as an S Corp vs. being a W-2 employee

While S Corps and W-2 employees can both provide services for a company, it’s essential to understand the difference if you get the opportunity to choose. The difference results in varying levels of responsibility, flexibility and obligations between parties and it’s advantageous to understand and compare your total compensation and cash flow in either instance. 

Providing services as an S Corp 

If you form a business and elect S Corp tax status, you’re creating your own small business and working for companies through a business-to-business (B2B) relationship. You’re responsible for all aspects of managing your company, including establishing a legal business structure, seeking and securing contracts, invoicing, managing bookkeeping and filing and submitting business and payroll taxes for yourself. 

This option is advantageous if you’d like to avoid traditional corporate roles and want to seek opportunities to be in control of your workload and have various clients.

Providing services as a W-2 employee

If you opt to be a W-2 employee, things are much simpler. There’s no need to establish a business, seek contracts or remit your own payroll tax. Rather, you work directly for another business as an employee and receive a regular paycheck. Your employer can dictate your work schedule, how you perform your work and where you work, however the tradeoff is a much simpler tax profile. 

Employees don’t have to worry about the overhead of managing a business and often qualify for employer-provided benefits, like health insurance or retirement matching. This path is advantageous if you like the ease and simplicity of working for one employer and you accept the restrictions that come with traditional employment. 

Pros and cons of forming an S Corp

If forming an S Corp means taking on the responsibility of managing your own company, why would someone do that rather than become an employee? It really depends on your unique circumstance, personality and goals – and if you’re inclined to be more independent, accepting contract work through an S Corp may be the path for you.

Benefits of an S Corp

Flexibility and control

People who lean towards working for themselves are typically seeking independence and control over their work. While most individuals who accept traditional W-2 roles commit their work time to a single employer, an S Corp owner can serve multiple clients in varying industries, and commit different amounts of time to each.

Being a business owner allows an individual to dictate their own schedule and the manner in which they complete their work and from where. While certain benchmarks are agreed upon in a B2B relationship, like project deadlines or hourly rates, being self-employed under an S Corp allows the business owner to maintain control of their work groove.

Being self-employed under an S Corp allows you to control your earning potential, the type of clients you serve and the ability to scale, or maintain a client base to suit your lifestyle and needs.

Tax Savings

S Corps also have tax advantages. Without an S Corp election, a contract worker would likely report taxes as a sole proprietor or single-member LLC. Tax reporting for a sole proprietor or single-member LLC results in a hefty self-employment tax bill assessed on the entire business profit – then income tax is assessed on top of that.

On the contrary, An S Corp election requires the owner to pay themselves a reasonable compensation – a formal salary that runs through a payroll process. Then, only the salary is subject to self-employment taxes rather than the entirety of the business profits. 

An S Corp owner receives compensation through a combination of owner salary and owner’s distributions. The owner’s distributions are not subject to payroll taxes. Electing S Corp status gives you an opportunity to reduce your tax liability by avoiding self-employment tax on your business profit. Instead, you’ll pay payroll taxes on your owner salary.

As an added benefit, S Corps are entitled to write off expenses that are considered ordinary and necessary for generating revenue. This means you have the ability to deduct costs like your home office, travel expenses and softwares and equipment required to perform your job.

Downsides of an S Corp

Administrative Burden

Electing S Corp status immediately triggers the need for increased overhead costs. An S Corp requires more comprehensive bookkeeping (you need to report a Profit & Loss and a Balance Sheet), requires a payroll service (to pay yourself a reasonable salary) and requires filing a separate business tax return.  

While the administrative burden comes with its own costs, the savings advantage can still outweigh the financial strain of hiring a professional. Plus, there are services (like Collective) who specialize in supporting single-owned businesses who want to elect S Corp status.

Providing your own benefits

As an S Corp owner, you are responsible for your own benefits, including healthcare and retirement, which are added costs that entrepreneurs should consider when deciding between regular employment and being self-employed.

While these benefits are available to provide to yourself under the S Corp, it is on the business-owner to identify the plans or policies and pay for premiums. The silver lining is these costs will become a deductible business expense for your S Corp.

Pros and cons of becoming a W-2 employee

Like S Corps, choosing to be a W-2 employee has pros and cons that you should consider before filling out any employment paperwork.

Perks of being a W-2 employee

Simplicity

As a W-2 employee, you don’t have to do anything but sign your offer letter, provide direct deposit information and start working. You’ll work the agreed-upon schedule in an office or remotely, opt into employer-provided benefits and perform your duties under the instruction of your employer.

As a regular employee, you are free from the overhead costs and complexity of running your own business. When it comes to tax purposes, it can be simpler to file your personal tax return when you are a W-2 employee. While S Corp owners file a separate business tax return, W-2 employees only need to file their personal income tax return each tax year.

Employer-provided benefits

Every employer offers different employee benefits, however most regular employment opportunities are eligible for benefits, such as vacation and sick pay, paid parental leave, retirement benefits, and health insurance. 

Downsides of W-2 employment

Control over workload 

As a W-2 employee, you are engaged to a single employer and must comply with their employee handbook, code of conduct and any non-compete rules. This may prevent you from engaging in outside business activities, like seeking other contracts or outside employment. 

Social Security and Medicare Tax

While tax filing is much simpler as an employee, an employer dictates your salary, meaning they also dictate how much you contribute into social security and medicare tax. W-2 employees pay half of FICA taxes since their employer pays the other half. If you work multiple jobs or switch jobs during the year, you could risk paying into these payroll taxes in excess. 

Inability to write off expenses

Some employee roles require out-of-pocket expenses. As a traditional employee, the IRS discontinued the ability to deduct unreimbursed expenses. If you travel for work, work remotely or otherwise incur costs that are not reimbursed, there is no tax advantage or opportunity to reduce your tax bill as a regular employee. 

Choosing between becoming an S Corp or a W-2 employee

If you’re in a position to choose between accepting a contract role as an S Corp or traditional W-2 employment, ask yourself these questions:

• What do you want your relationship with work to be? 
• Do you prefer the ease of a simple tax filing, employer provided-benefits like health insurance paid time off?
• Do you want to have control over your work environment and schedule, have multiple contracts serving different industries?
• Consider the total compensation package between a W-2 employee vs. the contract rate. If accepting the contract means forfeiting benefits like health insurance, retirement matching, paid time off and parental leave, how should your rate be adjusted to provide yourself with these benefits?

The bottom line

Forming an S Corp or taking on a W-2 employee role both have pros and cons. In many cases, if the choice is given to you, the best path will greatly depend on your own unique circumstance, professional goals and commitment to being a business owner. If you opt for joining the millions of individuals opting for self-employment, be sure to understand your obligations and responsibilities as a business owner. 

If being self-employed is the path for you, find out how Collective supports solopreneurs in becoming S Corps here.