Suddenly Employee » From: Pittsburgh, PA Dear TaxMama: Normally, I work as a 1099 with clients. However, this potential client wants me to work on a contract, through another firm as a W2. The problem is that firm will not seperate billable hours from expenses. Will I be able to recover all of my expenses "airfare, car rental, hotel, meals" as a W2 employee or will I be losing money on that arrangement? Thank you for your time! Vince Dear Vince, Let me just clarify this, OK? (Get set for a looong reply.) You will submit an invoice for all your hours and your expenses. They will issue you one check and take withholding out of the TOTAL dollar amount? That's really odd. Please clarify it with them. I doubt that's the case. Most likely, they will issue one check, but only take withholding based on the wages. Regardless of how they do it, to protect yourself, keep a copy of all the expense reports AND the receipts you attach. (See IRS Publication 463: Travel, Entertainment, Gift, and Car Expenses) If they pay you based on the first, odd, scenario, here are the extra costs to you. Since they will be taking withholding out of the 'expenses,' they will cost you this much more: Social Sceurity/Medicare - 7.65% Any PA local taxes - (You'll need to look that up) In the second case, where they only take payroll taxes from the hourly rate, you won't have any of the extra costs mentioned above. But, I can't believe they will do this. In fact, if you submit complete expense reports to them, and they reimburse you, they are not required to include ANY of that amount on your W-2 at all. That's one of the benefits of an 'Accountable Plan' of employee reimbursements. And this is, most likely, what they will do. See pages 26 and 29 of Publication 463 to read about how Accountable and Nonaccountable Plans work. However, in both cases here IS what you will run up against. If you're not already itemizing your deductions (that means, using Schedule A, for mortgage interest, etc.), you will, essentially, be losing the benefit of your standard deduction. See the Corporate and Individual Tax Rates chart from SmBiz.com to see which amount applies to you. Assuming you're single, you've just lost a free deduction of $4,700 You have to report these expenses as Miscellaneous Deductions on Schedule A, (OK, first, you'll have to enter all the expenses into Form 2106 which will carry them to Schedule A - complicated, already, eh?) Now, take a good look at Schedule A, line 25. See where it asks you to enter 2% of the bottom line on page 1 of your Form 1040? That means you lose another chunk of your deductions. Let's say that your 1040, including your contract income, your regular 1099 income (less expenses), investment income, etc comes to $70,000. So, you've just lost another $1,400 worth of deductions. The next potential problem is that if your income is much higher, say, over $137,300, you start losing itemized deductions because there's a little quirk in the tax law. So, you might lose several thousand more dollars in deductions before you're done. Then, there's the Alternative Minimum Tax. Just the way the last category cuts deductions based on higher income, this one raises taxes, based on higher deductions. So, if you really have a lot of reimbursed expenses, you may lose the benefit of them because the tax system doesn't want you cutting your taxes. None of the above issues come into play when you are paid via 1099 and report all your income on Schedule C and deduct all your expenses there, as well. You get to use all your deductions, with none of the limitations mentioned in items 3 or 4. All in all, depending on your income, filing status, and deductions, this may cost you about $6,000 - $10,000 in lost deductions. That means, perhaps $2,000 - $4,000 out of your own pocket. Yes, it's a bit complicated. I just mentioned some of the issues. There may be more, but I don't know your personal tax profile. You may want to sit down with a good, local tax pro and compute your alternatives. Once you can see the full effect of being treated as an employee, you can negotiate a higher rate of pay to compensate for it. Generally, increasing your hourly compensation by about $5 would do it. OR, better yet, having them be sensible and treating all your expenses as an Accountable Plan would save you a great deal of trouble. Good luck! Best wishes, Eva Rosenberg Your TaxMama