401K Option for Worker paid with 1099-MISC

Dec 26, 2012
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Sorry if this long, but all the facts are needed to get a meaningful answer.
I have separated the following into time periods for convenient reference back:

March 2011 to May 31 2012: C works for a law firm and is habitually paid as an employee. C is paid with a two-month delay between billings and issuance of the resulting salary check, which is calculated as a percentage of the amount billed. Paychecks issued during this period include normal employee type deductions, and reporting for C's 2011 income is reported on W-2 form as would be expected.

Upon leaving employment on May 31, the firm owes C for the "tail" - i.e. the last two months of work. Payment is somewhat delayed, but the firm ultimately pays the employee in July 2012. However, the firm pays C without taking deductions and indicates that 1099-MISC reporting forms will be issued in connection with the "tail" payments, which total about $35K. C initially questions being paid in this manner, but the firm insists, apparently with the agreement of its accounting firm (a major big city firm), that payment in this manner is proper under the circumstances.

The payment raises the possibility of filing a form 8919 to reduce the amount of Social security and Medicare tax that C would pay if being treated as a contractor.

However, C notices that payment as a contractor opens up a possible benefit - that of possibly being able to make deductible contributions to an Individual 401K (to the tune of about $28K), even though this option entails paying higher social security and Medicare taxes than would be paid as an employee.

Note: During April and May 2012 - the period during which work was done that led to the delayed 1099 payments, C had not set up a corporation. Instead, the firm later treated C as a contractor at the time the payments were made in July/August 2012.

Question: Can C simply accept the employer's treatment of him as a contractor and pursue the 401K contribution? Or is C under an obligation to investigate the propriety of the firm's treating him as a contractor?

C wants the tax benefit, but doesn't want to get ulcers worrying about whether his actions conform to IRS rules.

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