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Is it a raise? Become a contractor vs. employee

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  • Is it a raise? Become a contractor vs. employee

    So I finally asked for a raise. I work 32hrs/week and make $16/hr. I need a bit more to make ends meet.

    They said ok, and offered me two choices:

    1. Stay on as an employee and take $18/hr

    2. Become a contractor (I already am telecommuting a fair amount) and take $20/hr

    I'm single and live in California.

    Feel free to give me a short answer, but if you have the patience to explain based on the below I appreciate it greatly.

    I'm sure some of you see this as an obvious situation but I just can't get the taxes aspect sorted. This is my day job, but I'm a generally creative person who just gets really confused about what in the end happens with taxes.

    Looking at a pay stub, as far as I can work out my current taxes being paid (I don't expect to owe taxes from experience in this sad bracket) is around 15-16%

    What will I pay in taxes as a contractor at that rate and hours? This works out to a little less than $30,000/yr
    (Let's just assume that I won't have a massive amount of deductions)

    I know I need to pay taxes. Generally online from what I've read in the last few hours, people say to set aside 30%. By this calculation I would have, all told, LESS as a contractor making $20/hr than I would as an employee making $18/hr.

    Doing my own calculations using turbotax and other calculators though tells a different story, that at that bracket I would pay a little less or about the same in taxes, and thus the higher hourly rate would work in my favor (obviously).

    So, what is wrong with me, what am I missing?

    •*"Self Employment Tax" covers Social Security/Medicare and is 15.3% Is that correct?
    •*At that tax bracket will I NOT have standard deductions? Will I be paying Federal Income tax IN ADDITION TO the "Self Employment Tax?
    •*Blerg. Confused.
    Last edited by onesungover; 11-28-2012, 01:38 PM.

  • #2
    Typically independent contractors receive less benefits (such as health care) than employees. Also, a contractor typically would not receive a 401(k) match.

    Comment


    • #3
      Originally posted by onesungover View Post

      •*"Self Employment Tax" covers Social Security/Medicare and is 15.3% Is that correct?
      •*At that tax bracket will I NOT have standard deductions? Will I be paying Federal Income tax IN ADDITION TO the "Self Employment Tax?
      •*Blerg. Confused.
      Self Employment Tax refers to Social Security/Medicare tax. Generally when you're employed, you pay half, and the employer pays half (8%/8% rounding up). When you're self-employed, you pay the full share, which would be the full 15.3% (I use 16% to be safe).

      All other things being equal, you can expect to pay ~8% more in taxes than you do now. 8% at this hourly rates is about $1.50 an hour. So again, all other things being equal, you're ahead to become a contractor. BUT, you have to look at what else you're giving up, such as health care, retirement, other benefits, etc to become a contractor.

      Being self-employed, you also have to file taxes quarterly, which can suck for awhile until you get used to it.

      So unless everything else you're giving up (aside from taxes) is less than .50 an hour in value, you're better of remaining an employee. As am employee you're also eligible for federal protections that you may not have being self-employed.

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      • #4
        This decision should be based primarily on benefits. Does your current job provide medical and/or retirement benefits to you? If they do, you'll probably lose them as a contractor and you have to contemplate whether that $2 extra per hour is worth losing your benefits. If you do not currently receive benefits, then it's a no brainer to become a contractor and make more money.

        Another consideration ... do you have more job security as an employee vs. a contractor?

        Comment


        • #5
          Originally posted by siggy_freud View Post
          All other things being equal, you can expect to pay ~8% more in taxes than you do now. 8% at this hourly rates is about $1.50 an hour. So again, all other things being equal, you're ahead to become a contractor. BUT, you have to look at what else you're giving up, such as health care, retirement, other benefits, etc to become a contractor.
          This is the answer. You WILL owe an extra 7.65% ($1.53 an hour). However, some of that (as well as other expenses) might be tax deductible if you are self employed. For example, you may be to deduct some expenses related to your house if you use a portion solely for the business (spare bedroom as office). Also, being self employed you can defer more income for retirement.

          The bottom line is that USUALLY the benefits offered by an employer are worth a LOT more than $2 per hour. If you don't have ANY of those benefits, then you may come out ahead anywhere from (my estimate) $0.50 to $1.00 per hour depending on your tax situation.

          Is it worth it? Personally, I don't think so. Also, don't forget that as a contractor you will not get paid holidays or vacation.

          Comment


          • #6
            Originally posted by humandraydel View Post
            This is the answer. You WILL owe an extra 7.65% ($1.53 an hour). However, some of that (as well as other expenses) might be tax deductible if you are self employed. For example, you may be to deduct some expenses related to your house if you use a portion solely for the business (spare bedroom as office). Also, being self employed you can defer more income for retirement.

            The bottom line is that USUALLY the benefits offered by an employer are worth a LOT more than $2 per hour. If you don't have ANY of those benefits, then you may come out ahead anywhere from (my estimate) $0.50 to $1.00 per hour depending on your tax situation.

            Is it worth it? Personally, I don't think so. Also, don't forget that as a contractor you will not get paid holidays or vacation.
            Thank you so much guys for simplifying the issues here. Seeing and doing the maths that I couldn't see. Thanks.

            Here are the caveats, and I'll just say that as they stand they make me lean pretty clearly to remaining an employee (despite the first one):

            • I receive no current benefits. Nada, no health, no matching nothin'. Yup. Took the job after being unemployed for way too long and that's one of the sub-topics of the bad economy.

            •*However, as a non-employee I would not be eligible for unemployment benefits if they were to drop me. In addition, a friend pointed out that subconsciously (or otherwise), it would be a lot easier for them to cut hours/part ways with a contractor than an employee.

            • Paying taxes quarterly would be something I wouldn't excel at to say the least (some of us just aren't on it with these things, not to make excuses, but... in other words the time spent preparing etc. may, for me, make it not worth it.

            •*My employer's general sell point on being a contractor was that I could deduct a lot. There's a fair amount that I could deduct, but not a lot. I'm not going on business trips for them etc. And I don't want to complicate things by shmoozing those numbers with the IRS per se.

            Dang. It goes to show that there's always more to $$$ than meets the eye.

            Comment


            • #7
              How comfortable are you in a bargaining position? Possible to come back to them with 19 per hour as an employee? Or perhaps 18, but get some kind of benefit in there? Sometimes I like to negotiate with benefits when I know I'm reaching the "cap" on salary. In my last (which was recent) negotiation, instead of going for the full dollar amount I wanted, I came down slightly and threw another week of paid vacay in there.

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              • #8
                Originally posted by onesungover View Post
                • I receive no current benefits. Nada, no health, no matching nothin'. Yup. Took the job after being unemployed for way too long and that's one of the sub-topics of the bad economy.
                What about my last point - paid vacation and/or holidays? You don't get any? I guess technically you are considered "part time", right?

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                • #9
                  One thing to remember is that in down times contractors are almost always let go before employees are.

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                  • #10
                    Originally posted by Goldy View Post
                    One thing to remember is that in down times contractors are almost always let go before employees are.
                    Generally yes, because they don't have to pay severance or unemployment for contractors. In some cases though, the savings of not paying a contractor's benefits saves them more, so employees go first and are back-filled by contractors. Given that the OP receives no benefits currently, he's better off as an employee.

                    OP, with the additional tax, you're essentially looking at .50 an hour more as a contractor. Not sure it's worth it to me, unless you REALLY aren't giving up anything. Its about $700 more a year after taxes. Not insignificant by any means, but again it all depends on what you're giving up. and how safe your industry is.

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                    • #11
                      Just to add -- as a contractor you will be on 1099 and depending on how you elect you will be responsible for paying your own taxes. You should ask a CPA if as a contractor you will be allowed to deduct certain IRS-approved expenses. That way, your net income will be lower on the tax return. There are pros and cons to both situations. Do the math before you decide.

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                      • #12
                        Originally posted by humandraydel View Post
                        What about my last point - paid vacation and/or holidays? You don't get any? I guess technically you are considered "part time", right?
                        Yes. I am considered part-time. That's the justification for no vacation/holidays. To be fair, that's where I need to be. I am a musician on the weekends and so I work four 8 hour days (at this job). If you're wondering why I don't report my income as a musician contractor it's because I really don't make any... yet.

                        That being said, what I am considering asking for as leverage right now are a few vacation days, plus performance bonuses (my job is to make them money through their website and marketing campaigns).

                        Siggy, I am terrible at bargaining. I'm kind of a softie, more or less. I know that that's bad. But I feel if I can come up with some attainable/justifiable goals and subsequent rewards then it will be fair for all. This is a Mom & Pop business with only a few employees to give that situation some context. Nonetheless I should come back with $18 or $19 (as an employee) with a few days (to start) vacation. It's not unreasonable to expect that given what I've already accomplished for their bottom line in a short time.

                        My brother broke the maths down this way for me:
                        "Stashing your own tax money and making quarterly payments to the IRS takes discipline. 30% is a good starting point but 40% is a common #. At least three of my friends have f%$@ this up big time and are in deep to the IRS, which is no joke. So, if you were making at least $16 + 40% (~$23) that would be something to consider but I think I'd take the $18 and move on with my day."

                        Again, THANK YOU SO MUCH to all for your thoughtful replies.

                        Comment


                        • #13
                          I too emphasis, you need to talk to an accountant who understands 'small contractor' business. The tax thing is simple, you can set up an on-line account and pay 20% - 30% of every cent you are paid. If you can set up a 'work-only' area of your home, you can deduct all costs associated with that space like rent, heat, electric, percentage of internet, percentage of phone, your cost of going to the work site on mileage rebate, office supplies, printer, cartridges, paper...you get the idea, anything for work but pro rated.

                          Understand that you are responsible for your operations, you are your own boss. Are you willing to be both disciplined and organized? For example, keep every bill and know where they are should the IRS request proof. Worse yet, you will need a mileage log to track date and mileage plus a time sheet [usually on computer] to track every hour you work. Once you get used to the idea it's just another routine.

                          Some people really enjoy the challenge and independence of contract work, others need direct supervision. It's really personal as well as financial. You will need to buy disability insurance and some kind of medical program.

                          Comment


                          • #14
                            Originally posted by onesungover View Post
                            Yes. I am considered part-time. That's the justification for no vacation/holidays. To be fair, that's where I need to be. I am a musician on the weekends and so I work four 8 hour days (at this job). If you're wondering why I don't report my income as a musician contractor it's because I really don't make any... yet.

                            That being said, what I am considering asking for as leverage right now are a few vacation days, plus performance bonuses (my job is to make them money through their website and marketing campaigns).

                            Siggy, I am terrible at bargaining. I'm kind of a softie, more or less. I know that that's bad. But I feel if I can come up with some attainable/justifiable goals and subsequent rewards then it will be fair for all. This is a Mom & Pop business with only a few employees to give that situation some context. Nonetheless I should come back with $18 or $19 (as an employee) with a few days (to start) vacation. It's not unreasonable to expect that given what I've already accomplished for their bottom line in a short time.

                            My brother broke the maths down this way for me:
                            "Stashing your own tax money and making quarterly payments to the IRS takes discipline. 30% is a good starting point but 40% is a common #. At least three of my friends have f%$@ this up big time and are in deep to the IRS, which is no joke. So, if you were making at least $16 + 40% (~$23) that would be something to consider but I think I'd take the $18 and move on with my day."

                            Again, THANK YOU SO MUCH to all for your thoughtful replies.
                            It does take discipline to do the self employment tax, however it's not nearly as dire as what your brother laid out. It's not like you're not paying any tax on the $16 an hour now. In fact, you're paying all the same tax you would, minus the 7.3% extra you'd be paying for your share of medicare/social security. Nothing else changes. That's why I said all other things being equal, $18 an hour as an employee is equal to $19.5 per hour as a contractor. $20 an hour puts you ahead, though with a bit more work on your end.

                            The reason why people play it so safe is that being self employed requires you to pay estimated taxes. If you don't pay enough, you could be liable for penalties. People generally overestimate their tax burden so they don't end up owing tax or penalty. We do the same thing as employees with a smaller measure of control via how many deductions we take on our W2.

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