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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.

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    Don't forget vacation and holidays. As a contractor you can't bill for days you aren't at work. – mhoran_psprep Mar 8 '12 at 13:29
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    This is why generally companies pay more for a contractor than they pay in salary to their employees. – user4127 Mar 8 '12 at 14:10
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    I answered a related question, "How can I determine a good rate for freelancing?", at one of our sister sites, the startups SE. See answers.onstartups.com/q/1758/953 .. it answers the reverse question (trying to go from a salary to a comparable freelancer rate) – Chris W. Rea Mar 8 '12 at 14:49
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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.

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    A consultant might also want to negotiate for payment at a different (and higher rate) with a client who wants something by the end of the week on a one-time deal than with a client who offers a long-term contract. Unless, of course, the consultant is advertising something like "Have gun, will travel; $100/hour" in the local newspaper or trade magazine to drum up business and will take anything that is offered. – Dilip Sarwate Mar 8 '12 at 14:31
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    Don't forget vacation and holidays. As a contractor you can't bill for days you aren't at work – mhoran_psprep Mar 8 '12 at 14:45
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    @mhoran_psprep I think The English Chicken's 2000 hours per year accounts for a short vacation since 52 weeks minus 2 weeks vacation times 8 hours equals 2000 hours. Also, if a consultant has to be present "at work" at the employer's office in order to bill for time, there is a possibility that the IRS will deem the consultant a statutory employee instead of a consultant. – Dilip Sarwate Mar 8 '12 at 15:09
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    Typically a company billing the US government for an employees time can't bill for more than 1800-1900 hours a year. The hourly rate does have to account for 10 days of holiday, 2 weks of vacation, plus a little sick time. The employee receives checks for 2080 hours. A contractor determining their rate has to understand this difference. – mhoran_psprep Mar 8 '12 at 15:17
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    There is a fairly good calculator here rakkar.org/ContractPayCalculator.html – Josh C Jan 24 '15 at 22:46
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Take $100,000 base salary, x 1.5 = $150,000 contractor salary, divide by 1,872 hours = $80/hr

  • x3 for a safety net a prudent contractor will budget as if they will only be working 50% of the time – Pepone Feb 24 '15 at 21:21
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    Welcome to Personal Finance & Money. Please visit the Help Center for tips on how to write a great answer. In this case, for example, your response would benefit quite a bit from an explanation of why you use the terms 1.5 and 1872. – dg99 Feb 24 '15 at 22:59

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