Choosing between corp-to-corp and W2 comes down to who absorbs the costs: a W2 job makes you a direct employee with taxes withheld and benefits included at a fixed salary, while a corp-to-corp (C2C) contract pays your business a gross rate and hands every tax, benefit, and administrative expense to you. The headline numbers almost never compare fairly. A $120,000 W2 salary and a $120,000 C2C contract are not the same offer, and treating them as equivalent is the mistake most people make when they first see a C2C rate that looks generous.
Here’s what actually separates the two, and how to translate one into the other.
What Each Arrangement Actually Is
As a W2 employee, the hiring company employs you directly. Under federal regulations, an employment relationship exists when the business has the right to direct the details and methods of your work, not merely the end result.1eCFR. 26 CFR 31.3121(d)-1 – Who are employees The company sets your hours, provides equipment, and can discipline or fire you. It also carries the administrative weight: withholding federal and state income tax, deducting your share of Social Security and Medicare, sending those amounts to the IRS, and issuing a Form W-2 at year-end. Group health insurance, retirement plan matching, paid time off, and unemployment insurance coverage typically come with the job.
A C2C arrangement isn’t employment at all. The hiring company signs a contract with your business entity — an LLC, S-corporation, or C-corporation — to buy defined services. The firm cares about deliverables and deadlines, not how you get the work done. You choose your tools, set your schedule, carry your own insurance, and pay every tax yourself. If the hiring company starts dictating your methods, assigning you a desk, or requiring you to attend staff meetings the way an employee would, the arrangement starts to look like disguised employment regardless of what the contract says.
The Tax Gap
Taxes are where the two models diverge most sharply, and where the confusion lives.
How W2 Withholding Works
Your employer withholds 6.2% of your wages for Social Security and 1.45% for Medicare from each paycheck, then matches those amounts on its own side for another 7.65%.2Internal Revenue Service. Topic no. 751, Social Security and Medicare withholding rates You never see the employer-side cost, but it’s real. The Social Security portion applies only to earnings up to $184,500 in 2026; wages above that ceiling are exempt from the 6.2% on both sides.3Social Security Administration. Contribution and Benefit Base Medicare has no cap. Your employer also pays federal unemployment tax (FUTA) at 6.0% on the first $7,000 of your wages, typically reduced to an effective 0.6% after credits, plus state unemployment and workers’ compensation premiums.4Internal Revenue Service. 2026 Publication 926 All of it evaporates in a C2C arrangement.
How C2C Taxes Work
The hiring company pays your business the full contract amount with nothing withheld. Your company handles every tax obligation internally. Payments exceeding $2,000 in a calendar year (a threshold that increased from $600 starting in 2026) get reported on Form 1099-NEC.5Internal Revenue Service. Form 1099 NEC and Independent Contractors
If you operate as a sole proprietor or single-member LLC taxed as a disregarded entity, you owe self-employment tax of 15.3% on your net earnings: 12.4% for Social Security and 2.9% for Medicare.6Internal Revenue Service. Self-employment tax (Social Security and Medicare taxes) That 15.3% covers both the employee and employer halves that would normally be split at a W2 job. The Social Security portion caps at the same $184,500 in net earnings for 2026, and high earners face an additional 0.9% Medicare surtax above certain income thresholds.2Internal Revenue Service. Topic no. 751, Social Security and Medicare withholding rates
Nobody withholds for you, so you make quarterly estimated tax payments covering both income tax and self-employment tax. The deadlines are April 15, June 15, September 15, and January 15 of the following year.7Internal Revenue Service. Individuals 2 Miss them and the IRS charges an underpayment penalty, even if you’re owed a refund when you file your annual return.8Internal Revenue Service. Estimated taxes
The S-Corp Move
This is the strategy most experienced C2C contractors eventually adopt, and it can save thousands a year. If your entity elects S-corporation tax treatment, you split your income into a salary you pay yourself and distributions of remaining profit. Only the salary portion is subject to Social Security and Medicare taxes. Distributions are not, because federal law excludes corporate dividends and similar payments from the definition of net self-employment earnings.9Office of the Law Revision Counsel. 26 USC 1402 – Definitions
The catch: the salary must be “reasonable.” The IRS and courts have consistently ruled that S-corp shareholders performing services for the company cannot characterize all their compensation as distributions to dodge employment taxes.10Internal Revenue Service. S corporation employees, shareholders and corporate officers Reasonable means comparable to what someone with your skills and experience would earn doing similar work. If you’re a software consultant billing $200,000 a year and paying yourself a $30,000 salary, expect a reclassification.
A realistic example: you earn $150,000 through your S-corp, pay yourself a $90,000 salary, and take $60,000 as a distribution. You owe the full 15.3% in payroll taxes only on the $90,000 salary. That saves roughly $9,180 compared to paying 15.3% on the entire $150,000. In exchange, you run payroll, file quarterly payroll tax returns, and maintain corporate formalities.
C2C contractors operating through a pass-through entity may also qualify for the Section 199A deduction of up to 20% of qualified business income. For 2026, it begins phasing out when taxable income exceeds $403,500 for joint filers or $201,750 for other filers, with additional restrictions for consulting, law, accounting, and health care. W2 employees can’t claim this deduction on wage income, which widens the after-tax gap at certain income levels.
Comparing a W2 Salary to a C2C Rate
A $120,000 W2 salary is not equivalent to a $120,000 C2C contract. To earn the same effective income on a C2C basis, your rate has to cover every cost your employer used to absorb. Add these on top of the equivalent W2 salary:
- Employer-side payroll taxes. 7.65% for the employer’s share of Social Security and Medicare, plus FUTA. On $120,000, that’s roughly $9,180 to $9,600.
- Health insurance. Employer group plans typically cost far less than individual coverage. If your employer was paying $8,000 to $15,000 of your annual premium, you now pay the full amount. You can deduct 100% of your health insurance premiums as a self-employed individual on your personal return, which softens the blow but doesn’t eliminate it.11Internal Revenue Service. Instructions for Form 7206
- Retirement contributions. No employer match. If your previous employer matched 4% of a $120,000 salary, that’s $4,800 gone. You can still fund a Solo 401(k) with an elective deferral limit of $24,500 in 2026, plus $8,000 catch-up if you’re 50 or older, plus an employer profit-sharing contribution of up to 25% of your compensation. The contributions come entirely from your own earnings.12Internal Revenue Service. 401(k) limit increases to $24,500 for 2026, IRA limit increases to $7,500
- Paid time off. W2 employees typically get two to four weeks of paid vacation plus holidays. On C2C, every day you don’t work is a day you don’t bill. Budget for at least 10 to 15 unbillable days per year.
- Business insurance. General liability and professional liability (errors and omissions) coverage, commonly required at $1,000,000 per occurrence. Several hundred to a few thousand dollars annually.
- Administrative costs. Accounting, bookkeeping, payroll processing if you’re an S-corp, and state LLC fees ranging from $0 to over $800 depending on the state.
A common rule of thumb: your C2C hourly rate should be 40% to 50% higher than the equivalent W2 hourly rate. If a W2 role pays $60 per hour, you’d want roughly $84 to $90 per hour on C2C to break even after covering these costs. Adjust for your tax bracket, state taxes, and how much you value the benefits you’re replacing.
h2>What You Give Up on C2C
Health Insurance
W2 employers subsidize a large portion of group health premiums. On C2C you buy coverage on the individual market. The average monthly marketplace premium after applicable tax credits is projected at $50 for the lowest-cost plan in 2026, but that assumes you qualify for subsidies.13CMS. Plan Year 2026 Marketplace Plans and Prices Fact Sheet Without subsidies, premiums run considerably higher. The self-employed health insurance deduction lets you take the full cost off your personal return but doesn’t reduce the cash outlay during the year.11Internal Revenue Service. Instructions for Form 7206
Unemployment and Workers’ Compensation
W2 employees are covered by unemployment insurance funded through employer FUTA and state unemployment taxes. When a C2C contract ends, there’s no unemployment claim to file, because you were never on anyone’s payroll. Workers’ compensation similarly doesn’t apply. If you’re injured while working, your own health insurance or a voluntary workers’ comp policy is the only coverage. A cash reserve for gaps between contracts is one of the most overlooked parts of running a C2C business.
Retirement Plans
There’s no employer match, but the ceiling is high if you’re disciplined. A Solo 401(k) allows up to $24,500 in employee deferrals for 2026, plus a 25% employer profit-sharing contribution from your business, plus $8,000 in catch-up contributions at age 50 or older.12Internal Revenue Service. 401(k) limit increases to $24,500 for 2026, IRA limit increases to $7,500 A SEP IRA is a simpler alternative allowing contributions of up to 25% of net self-employment income.
Misclassification: A Risk Both Sides Should Know
Misclassification is what happens when a company treats a worker as a C2C contractor but the actual working relationship looks like employment. The IRS, the Department of Labor, and state agencies all scrutinize these arrangements.
If the IRS finds a company misclassified an employee as a contractor, the company owes back employment taxes. Under Section 3509, the liability is reduced to 1.5% of wages for income tax withholding and 20% of the employee’s share of FICA taxes, but only if the company at least filed the required information returns like a 1099. If it didn’t file those forms, the rates double to 3% and 40%.14Office of the Law Revision Counsel. 26 USC 3509 – Determination of employer’s liability for certain employment taxes These reduced rates are a concession. If the IRS finds the misclassification was intentional, the full tax liability applies with no discount, plus penalties and interest.
Workers can request a formal classification determination from the IRS by filing Form SS-8. The IRS reviews the facts of the working relationship and issues a ruling on whether the worker should be treated as an employee.15Internal Revenue Service. Independent contractor (self-employed) or employee? The process can take months but creates a binding determination.
The practical takeaway for a contractor: if a hiring company tells you where to sit, what hours to work, provides your equipment, and controls your workflow, you may be an employee regardless of what the contract says. That matters because if the arrangement is later reclassified, you could owe back taxes on income you already spent. Maintaining genuine independence protects both sides.1eCFR. 26 CFR 31.3121(d)-1 – Who are employees
What Running C2C Actually Requires
Before signing a C2C contract, you need a legal business entity. Most contractors form an LLC and elect S-corp tax treatment once income justifies it. You’ll need an Employer Identification Number from the IRS, obtainable immediately online or by mailing Form SS-4 (allow four to five weeks by mail).16Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN) The hiring company will ask for a completed Form W-9 and, in most cases, certificates of general and professional liability insurance before approving your vendor setup. A professional services agreement should cover scope, payment terms, termination, intellectual property, confidentiality, and indemnification.
The ongoing compliance load is real. Quarterly estimated taxes on April 15, June 15, September 15, and January 15.8Internal Revenue Service. Estimated taxes If you elected S-corp treatment, regular payroll for your reasonable salary and Form 1120-S by March 15.17Internal Revenue Service. Instructions for Form 1120-S LLCs taxed as sole proprietorships report on Schedule C with the personal return by April 15. Most states require annual reports or franchise tax filings to keep the entity in good standing. Insurance policies must stay current — a lapse can violate contract terms and leave you exposed. Records of contracts, invoices, receipts, and filings should be kept for at least three years, or six if there’s a substantial understatement.
Most C2C contractors spend several hours per month on bookkeeping, invoicing, and compliance that a W2 employee never thinks about. That time is a real cost. Build it into your rate, and consider hiring an accountant who works with small businesses or contractors — the fee pays for itself in avoided penalties and captured deductions.