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I am aware of the general differences between being an employee and being an independent contractor. However, I am unable to easily compare the two when it comes to after-tax compensation.

Company A: You're a contractor (1099). You get paid $X/hour. You genuinely act like a contractor and aren't secretly an employee.

Company B: You're an employee (W2). You also get paid $X/hour. You genuinely act like an employee and aren't secretly a contractor.

If absolutely everything about the two companies are the same except your status as an employee/contractor, you'd be better off as an employee because you end up paying less taxes. Your after-tax income will be higher. But where's the dividing line? Is there a simple formula that tells you the equivalent employee rate given a specific contractor rate? I completely understand that this involves simplifications and won't be perfectly accurate.

Chris W. Rea
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colithium
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2 Answers2

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Here are a few points to consider:

  • Taxes: As a consultant, you will be responsible for the employer portion of the Social Security and Medicare taxes, and you might have to pay for state unemployment insurance and state disability insurance, as well.

  • Office expenses: As a consultant, you may be required to buy your own laptop, pay for your own software licenses and buy other office-related supplies. For higher-end services, you may be setting up a complete office and even hire your own secretary and other support staff.

  • Benefits: As a consultant, you will be responsible for your own health insurance, retirement plan and other benefits that an employer would ordinarily provide.

  • Education: Your employer will likely pay for books and magazine subscriptions and send you to seminars, in order to keep your skills current; your client won't.

  • Liability: Consultants face certain liabilities that employees don't, and have to factor the cost of insuring against those risks into their rate. Let's say you're a software developer, and your faulty code causes a nuclear plant's reactor core to overheat and melt down. As an employee, you'll get fired. As a consultant, you will get sued. Even consultants in low-risk fields can easily shell out thousands of dollars per year for a basic general liability policy.

  • Sales & marketing: Don't forget that when your contract ends, you will have expenses associated with finding your next client, including the opportunity cost of not getting paid for your services during that time.

All these factors contribute to your overhead, which you have to roll into your consulting rate. You should also add a margin of profit -- after all, as you're in business for yourself, you should be compensated for taking this entrepreneurial risk.

If you're looking for a quick over-the-thumb rule, you can figure that your equivalent consulting rate should be about twice what you would be paid hourly as an employee. Assuming you work 2,000 hours a year, if you would receive a $100,000 salary, your hourly rate should be $100. Of course, this is only a very rough guideline. Ultimately, your rate will mostly be influenced by how established you are and how much your services are in demand.

Tony the Pony
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Take $100,000 base salary, x 1.5 = $150,000 contractor salary, divide by 1,872 hours = $80/hr

George
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