I am a full time employee and am considering switching to consulting and doing contracts for different clients. I am being offered a contract position at a rate that's higher than my current salary, and I am trying to determine if that rate is worth the switch.

When switching from being a direct employee to contract work, what factors should I consider as I evaluate the difference between my full time salary and my contract rate?

  • is that 2 hours / week for one client? or 20 hours a week for two? – Solar Mike Jan 31 at 16:17

There are a number of differences in cost for a contractor versus a direct employee. If you're considering making the switch, you should make sure you have considered all of these costs:

  • Salary. Of course, you want your ultimate take home pay (in terms of cash in your pocket) to be something you're happy with. The default is to make sure you are taking home a comparable salary, but many contracts choose to become contractors because they see themselves as specializing and becoming expert in a particular skill, and hence they're interested in being able to charge more for their particular skill set, in terms of take home pay. Simply, many contractors expect contracting to be more profitable than direct employment.
  • Other benefits paid by your current employer. If you're in the US, your employer is probably paying for at least a portion of your health insurance. They may also be paying for other benefits you won't have paid for as a contractor - PTO, vision, dental, or life insurance, a 401k or other retirement plan, and so on.
  • Tax implications. It's clear to most people that your employer facilitates your income taxes. Depending on your contracting arrangement, you may be liable for additional taxes or you may be taxed in a different way. For instance, you may be liable for social security taxes beyond what you're currently having withheld from your paycheck. And, if your income is substantially higher, you may be in a higher tax bracket than you're used to. It's best to check with a tax professional to make sure you understand the full impact of this point.
  • Stability/Risk. Being a full time employee is usually considered low risk. There's an implication that you have a job and your employer intends to keep you employed. As a contractor, your relationships with employers will typically be short term in nature. You may be hired for 6 months. What happens when that 6 months is over? You need to find another job! What happens if no one wants your skills, and it takes you another 6 months until you land your next contract? You need to plan for a utilization rate (a percentage of the time you'll be employed) and bake that in to your hourly rate.

Different circumstances will play out differently, and it's hard for us to tell you if a particular number is "worth it" in a general sense. That said, my exposure to contracting has been that on the low end, the salary multiplier is typically in the neighborhood of 1.5x - 2x, and at the high end, it may be as high as 4x.

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  • 1
    For the second bullet, your employer is also paying half of the Social Security obligation, which you will pay all of as an independent contractor – cdkMoose Jan 31 at 17:26
  • Good point, I added an entirely new bullet about tax implications. – dwizum Jan 31 at 17:29

The answer given above is solid and comprehensive. There are many risks of being a contractor as have been indicated but surely it is important to be sure you will be paid on a W-2 opposed to a 1099 (in which the employer withholds zero taxes and you will be responsible for paying these in the end and it could be substantial. Additionally, on a W-2, you would likely not be responsible for carrying liability insurance, which is often required for a 1099 contractor and some employers will require Error and Omissions insurance which comes at a high cost premium to the contractor. With respect to stability, also keep in mind, while this may result in a long term engagement, there could be flexibility in the hours you work. As a hourly W-2 employee, you are only paid for the hours you work AND you are paid for all of the hours you work unlike a full time salaried employee. There are a lot of rules and regulations in many states that govern what constitutes an employee vs. a Contractor (as most contractors are paid on a 1099 and operate as their own business so to speak). When all is factored in, depending on the terms you have with the company, the increase in rate may not be a lucrative as it appears.

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Start by looking at your pay stub.

Look at your pay stub for W2. As a 1099 contractor, you'll have to pay double what your employer deducts for social security and medicare. It's called self-employment tax.

Look at what your employer withholds for taxes. As an independent, you will have to pay quarterly estimated tax in about the same amounts (or maybe a little more).

Other company-paid benefits? (Health, life, vacation)? All that becomes your personal responsibility.

You won't see how much what your company pays into your state's unemployment compensation fund. But, as an independent contractor you won't be able to draw unemployment compensation if you don't have work.

Get a copy of Schedule C of the federal income tax forms. It has a box for each kind of cost-of-doing-business you might incur as an independent. Those costs are tax-deductible. But you still have to pay the costs of doing business. Schedule C is a nice checklist to remind you about the stuff you'll have to do.

If you're looking for comparable take-home pay to your present W-2 gig, you probably need to charge at least 20% - 25% more per hour than you currently make. But before you decide your rate, price out health insurance; if you have to pay for it yourself it could cost a lot.

Make an appointment with https://score.org/ . They offer free advice to people considering going into business for themselves, and they can help you sort out how to do this well.

Pro tip Be careful taking the home-office tax deduction. Lots of people try to abuse it, so the IRS likes to audit returns with it on there.

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