Switched from W-2 to K-1: What Are the Pros, Cons, and How to Save on Taxes?

Someone on Reddit said their spouse was switched from W-2 to K-1 at the medical practice where she works but was given no paperwork or discussion on partnership; they noticed when her wages went up (no taxes withheld). They asked: What's the process of going from W-2 to K-1? Should she have been given new paperwork or a contract? Now that she's on K-1, what tax benefits can we use? With no withholding they expect a hefty tax bill at filing time. What are the disadvantages (e.g., employer and employee used to split Social Security and Medicare, so should her pay rise to offset the extra tax)? Switching from W-2 to K-1 usually means a move from employee to partner or member of an LLC or partnership. There are potential tax benefits (business deductions, half self-employment tax deduction, possible QBI deduction) and downsides (no withholding so a large year-end bill including self-employment tax, more complex reporting, possible loss of some employee benefits). She should receive partnership documentation; plan for estimated tax and request clarification from the employer if not.

Bottom line: Switching from W-2 to K-1 typically means a transition from employee to partner or member of an LLC or partnership. Pros can include business expense deductions, the deduction for half of self-employment tax, and possibly the Qualified Business Income (QBI) deduction (e.g., up to 20% under IRC § 199A). Cons include no withholding (so a significant tax bill at year-end, including self-employment tax), more complex reporting, and possible loss of employee benefits (e.g., employer health contributions). It is standard to receive a new agreement or partnership documentation; request it from the employer. Set aside funds and consider estimated tax payments; consult a tax professional for your situation.

Question from Reddit

Employer switched me from W-2 to K-1. Pros/cons? How can I maximize tax savings?

My wife was recently switched from a W2 employee over to K1 at the medical practice she works at but hasn't been given any paperwork or discussion on partnership. I recently found out as she pointed out her wages had gone up dramatically.

What's the process of going from W-2 to K-1? Should she have been given new paperwork or contract to sign?

Now that she is K1 are there tax benefits we can take advantage of? Currently no taxes are being withheld from her paycheck so I assume we're going to have a hefty bill come tax prep time.

Are there disadvantages of this structure we should be aware of and push back against the change? The one thing I could think of is that for W2 employees, the employer and employee split Social Security and Medicare taxes. So at the minimum her pay should be increased to offset that tax burden that she fully carries.

Would appreciate any thoughts!

Source: Reddit

Analysis

The inquiry involves understanding the implications of a switch from W-2 employment to K-1 income reporting, including potential tax benefits and disadvantages. The user seeks clarity on:

The process of this transition
Necessary documentation
Strategies for maximizing tax savings while considering the added tax responsibilities associated with K-1 income

Answer

Switching from a W-2 to a K-1 often indicates a transition from employee status to a partner or member of an LLC or partnership. This change can have several tax implications.

Pros

Potential tax deductions: K-1 earnings may allow for various business expense deductions that were not available as a W-2 employee.
Self-employment tax deduction: If treated as self-employed, she may be able to deduct half of her self-employment taxes on the individual return.
Qualified Business Income Deduction (QBI): Depending on the nature of the business and income, she may be eligible for a deduction of up to 20% on qualified business income (IRC § 199A).

Cons

Increased tax liability: With no taxes withheld, she may face a significant tax bill at year-end, including self-employment tax.
Complexity in reporting: K-1 income can complicate tax filings, as it requires proper accounting for partnership income and expenses.
Loss of employee benefits: As a partner, she may lose certain employee benefits, such as health insurance contributions from the employer.

Process and documentation

It is standard for individuals transitioning to K-1 income to receive a new agreement or partnership documentation outlining their responsibilities and benefits in the partnership. It is advisable to discuss this with the employer to ensure proper documentation. For a deeper analysis of your situation and estimated tax impact, you can create an account with Margen to model different scenarios and plan for estimated payments.

Applicable Sections

Federal / IRS

IRC § 199A: Discusses the Qualified Business Income deduction, which may apply to K-1 income.
Publication 541: Explains partnerships, including the tax treatment and reporting requirements for K-1 income (IRS Publication 541).

Practical Notes

Set aside funds for tax liabilities since no withholdings are occurring. Consulting with a tax professional can help strategize on estimated tax payments.
Keep detailed records of any business-related expenses that can be deducted, which can significantly reduce taxable income from K-1 earnings.
If the employer has not provided documentation, request clarification on her status and any related agreements to ensure compliance and understand her rights and obligations.
Margen can help you track K-1 income, model QBI and self-employment tax, and plan estimated payments; consider creating an account for a more tailored analysis.

Limitations

This answer does not cover state-specific tax implications or nuances related to the specific partnership structure. For detailed advice tailored to your situation, consult a tax professional or accountant. You can also use Margen to run scenarios and get a clearer picture of your tax position before filing.

Are you experiencing a similar problem?

Try Margen to work through resolutions and file your taxes correctly.

Try Margen

← Back to all articles

Employer Switched Me from W-2 to K-1: Pros, Cons, and How to Maximize Tax Savings? (Reddit Q&A)