Having 1099 income in addition to W-2 income provides you with a lot of flexibility in terms of retirement accounts and tax deductions. Prior to diving deeper into this topic let me explain that I do already have a day job that is W-2 income and provides all the benefits you would expect, including health and disability insurance, retirement benefits, etc. My preference in choosing 1099s over W-2s is with regards to additional income outside of my day job.

As previously discussed in another article, there are some differences in taxation between 1099 and W-2 income. For the same gross pay, you do get taxed more on 1099 income because the self employment tax. However, even in spite of this, I generally opt to maximize 1099 income because of the reasons in this article.

This photo, “Education Tax Deductions” is copyright (c) 2012 Chris Potter and made available under a Attribution 2.0 Generic License

What can I do with 1099 income that I cannot do with W-2 income?

1. Small business retirement accounts

When you are self-employed, you are technically a small business owner and are eligible to open certain small business retirement accounts. This includes individual 401(k), SEP IRA, and SIMPLE IRA. Each of these have different criteria and maximum limits to which you can contribute. I chose an individual 401(k) because it allows the largest contribution, and gives the option to put employee deferrals into a Roth 401(k).

Because I have an individual 401(k), I am allowed to make contributions on behalf of the employer, who just so happens to also be me! I have usually been able to put away several additional thousands of dollars into my retirement accounts in a tax-deferred manner this way.

2. Business deductions

As a young professional, you probably have a lot of conferences and meetings to attend. Each of these can cost several hundred to several thousand dollars. Personally, my specialty board exam each cost $2,200 of which I had to take two, one for pulmonary and one for critical care, in the span of two years. If these were not reimbursed by my employer, then I can itemize these as part of either my personal deductions, or as part of my small business.

What's the difference?

Miscellaneous deductions on your personal income must altogether exceed a 2% floor of your adjusted gross income in order to receive deductions. It is also the amount that is above the 2% floor at that gives you deductions. As an example, if you're making $200,000 for your adjusted gross income (AGI), and you spend $5000 on conferences, board exams, board exam review courses, then you will only be given deductions on the $1000 that is above the 2% floor.

With a small business, or 1099 income, these courses and conferences are part of your job. Thus, you are able to deduct them directly from your small business income. This is not subject to a floor as with personal income, meaning you immediately get tax benefits on the first dollar spent!

3. Home Office

If you truly have a home office, which has strict definitions per the IRS and is a prime flag for auditing, then you can deduct part of your home expenses as part of a home office. Especially in the burgeoning era of telemedicine, you could set up a room in your house as a home office for which you can deduct the electricity, Internet, phone, rent. Makes working from home even better eh?

What do you think? Do you prefer 1099 income or W-2 income? Please leave a comment below.