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Another Workplace SE answer describes the situation well in the USA:

[Many contractors are employed under] W2, [which] means that you're an employee of the contracting agency. They handle the billing and other overhead, pay payroll taxes and usually offer benefits (quality varies by company). They bill the client, usually about 50% or more higher than what you'll see. For example, they bill the client company $80/hr for your time and pay you $45/hr....

In general, you'll see about 20-30% more on an annual basis as a W2 contractor.

Often these type of W2 contractors will be hired directly by the company they are contracting by after some time. The idea being that that the employee has a trial period and can be easily let go if needed because "hey, they're just a contractor, they don't actually work for us." They company employing the contractors does not pay for health insurance, other benefits, or payroll taxes for the contractor, and pays the contractor more because of this.

When a contractor is hired directly by the company they are actually working for, there is sometimes a pay cut for the employee because now the company is paying for health insurance, other benefits, and payroll taxes for their new employee. (If there is no pay cut you effectively get a raise, "same good salary + new benefits!")

How much should this pay cut be typically?

The above quote suggests 20-30%, but those percentages can be ambiguous.

For example, if I am a contractor, and would normally expect a 70,000$ salary with benefits, I would mark up my salary 30% as a W2 contractor:

70,000 * 1.3 = 91,000

But come time to be hired, I would not expect a 30% pay cut (at least not calculated in the following way):

91,000 * .70 = 63,700

That is 10% below my target salary.

I use this example to establish that a salary markup and a salary cut are not equivalent and the way they are calculated varies. Please be aware of this when giving answers.

What is a reasonable pay cut when being hired and offered new benefits?

  • 3
    Are you just asking how to get back to 70K? If 70*1.3 =91; then 91/1.3 equals 70. – mhoran_psprep Jun 14 '13 at 10:49
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    In my experience, in my locale, contractors demand 80-100% more hourly pay than a salaried full-time employee working 40 hour weeks. – Telastyn Jun 14 '13 at 13:17
  • If you want an accurate answer, rule-of-thumb percentages aren't going to work. You're going to have to put a value on everything in the package you're being offered as an employee and see how it stacks up to what you were doing for yourself as a contractor. – Blrfl Jun 14 '13 at 15:46
  • "and pays the contractor more because of this" = I don't think that's necessarily true. That may be ONE reason why they pay more, but certainly not the reason. It has more to do with the benefits of having contractors on staff and the overhead costs involved (ie, paying the contractor management company) – DA. Jun 14 '13 at 21:50
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I wouldn't accept any pay cut, and I'd expect to actually net a bit more. The reason behind this is that the rate the end client is being charged actually factors in your W-2 taxes, and may factor in some benefits (only you know what you've been getting through the agency). Additionally, they are charging enough to make some profit.

Likely, the employer does not specifically know how much of the rate you are being billed at goes to you. They are already paying at least 2x what you get, so if you ask for what you get, that will probably sound delightfully low to them. They pay benefits to all their employees, regardless of salary, and many of those benefits, such as health insurance, won't be calculated as a percentage of your salary.

They're buying a known quantity that has been proven in the work environment, and this naturally has a higher value than someone they're interviewing fresh who might turn out to be a bad fit after they've paid her 5 months at whatever rate she cares to negotiate.

By contrast, I was working 1099 for the company I work for now (W-2), and I did take a 30% pay cut to go w-2.

  • 3
    In other words, two entities are profiting from the "end client" and so when one of those two entities (namely, the contracting agency in the middle) is cut out, there is no reason the remaining entity should be paid less. Thanks for that insight. – Buttons840 Jun 19 '13 at 19:29
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A better rule of thumb in the United States,especially when dealing with government contracting is that the customer is billed at 2x the rate the employee is paid.

The extra amount covers: the employee benefits including medical, dental, vision, life; matching social security and Medicare, and unemployment insurance. It is also used to fund the holiday, vacation, and sick leave hours.

They also have to pay overhead for the office space, office staff, office expenses.

Then they want to make a profit. Frequently that is around 8% of the fully burdened rate.

If you have a company supplying befits and providing services for you it seems like they take half the money, but it is more complex than that.

Example: Every 2 weeks your gross pay check is 4,000. You think you make $50 per hour or 104,000 per year for 2080 hours of work.

Your company is billing the government $100 per hour for the 1,840 hours of work you can be billed for during the year for a total of 184,000: 104K in pay, 65K in benefits and overhead, and 15K in profit.

The question is can you replace the benefits for that price and realize that they don't bill when you don't work. So they have to charge more to cover those costs. Taking the payments directly makes the most sense when your benefits are covered from another source: retired from the military, or coverage from your spouse.

Edit: The term "W2 contractor" in the original question doesn't make any sense. If you get a w2 you are an employee. The level of benefits are based on the company rules and labor laws. If you are contractor you get zero benefits, you are self employed and responsible for specific taxes. If Joe's contracting company is paying you 70K plus benefits, but you now want to work directly for the customer they will pay you 70K plus benefits as an employee (assuming the benefits are equal), or they need to pay you $70 an hour as an independent contractor. Of course the actual rates will need to be negotiated and depend on what benefits you are looking for.

  • I read the answer if you get a W2 you are an employee. If you are an employee you get a W2. It doesn't matter if you are working behind the counter at the pizza place, or your boss has you work at a location owned by somebody else. The IRS cares very much about these definitions. W2 is an employee, 1099 is not. – mhoran_psprep Jun 14 '13 at 14:43
  • The OP uses the following in the question: "For example, if I am a contractor, and would normally expect a 70,000$ salary with benefits, I would mark up my salary 30% as a W2 contractor The problem is that as a contractor he doesn't get benefits, and as a employee (W2) he doesn't get to set the rate they will bill their customers. – mhoran_psprep Jun 14 '13 at 15:22
  • The staffing agency I work for (and others I've seen) lets me set the rate I'm looking for work at, within reason. Whatever I'm asking for they'll present me at, and the range determines which openings they present me to. – Yamikuronue Jun 14 '13 at 18:41
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It all boils down to what you are worth relative to where your skills fit in the market.

I don't think this should be just a matter of: What were you paying before that the company is paying now? They will factor all that in but you don't have to. This is a negotiation.

Benefits of Being an Employee

Check your taxes and consider what they're going to pay compared to what you paid.

Healthcare could be a little tricky. Let's say you pay 100 per month (pick your currency this is hypothetical). The company offers a similar plan (good luck comparing the two) and you will only pay 25. What does the difference of 75/month mean?

This is going to give you an idea of what you may be willing to settle for along with some knowledge of what their offer is going to be based on. Do the math.

What you're really worth.

Was your contracting rate at the level of your expertise? Some people start out in contracting and may have been payed a lower fee because they were not experienced with a proven track record.

Has the market changed since you were hired or do you now have some better insight into what the market is like?

You should be able to leverage the fact that you are a proven employee and that is worth something or they shouldn't be hiring you.

Depending on how far off you were on your contract salary, you may try and negotiate for no paycut at all. You should still be testing the job market to see what you can get. Don't get locked into purely basing it on the contract salary minus full-time benefits.

Edit a little clarification:

If you are the full-time employee of the agency (W-2?), they are paying your salary and possibliy benefits. There is a markup because they had to seek the candidates, do some screening and then replace them if they don't work out. I don't think any of this has to do with your salary. You need to clarify what is your salary and does that include benefits (and the value of those benefits). Are you working on contract independanty or as "someone's" full-time employee with benefits?

  • I see the confusion of the W-2, and the OP indicates some sort of discrepancy based on taxes and benefits. I'll clarify my answer. – user8365 Jun 14 '13 at 17:07

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