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For many reasons I am moving from full time employee to a contractor with an associated company in a different city. Everyone I have spoken to says contracting is great except for the taxes and lack of benefits. I have never contracted for any company before.

From what I can gather the most important thing to do when changing over is to take careful note of your expenditures and "write off" what you can at the end of the year. My contract would be in Washington state, USA.

1) I am married and have 2 dependents, will I still be "nailed" on taxes or will there still be tax breaks?

2) What are the most important things tax wise I need to keep in mind for taxes with this transition?

3) What percentage of my "salary" should I expect to save for end of year taxes? From what I have read I want to save 30% to be safe?

4) Are there any good tips or tricks? Can I write off relocation costs, or if i have a home office can part of my rent be tax deductable?

5) Would it be wise to adjust my consulting rate to compensate for additional taxes, even if cost of living in the new city is lower?

Thank you for any answers.

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  • 2
    Are you allowed to incorporate and channel the money through the company?
    – Vitalik
    Mar 17, 2011 at 11:08
  • No I do not believe so.
    – pablo
    Mar 17, 2011 at 11:24

3 Answers 3

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1) I am married and have 2 dependents, will I still be "nailed" on taxes or will there still be tax breaks?

In my experience, you can't avoid much of the taxes, and it's not worth putting in a ton of effort to avoid them -- you're better off (efficiency / time-wise) increasing your billable hours to make up the extra.

2) What are the most important things tax wise I need to keep in mind for taxes with this transition?

3) What percentage of my "salary" should I expect to save for end of year taxes? From what I have read I want to save 30% to be safe?

Stash some cash. You will need to make four estimated tax payments per year. Drop 25-30% or so of each check you get into a savings account so that you have it ready when the estimated taxes are due. Having extra savings is better than not enough...

4) Are there any good tips or tricks? Can I write off relocation costs, or if i have a home office can part of my rent be tax deductable?

Tips:

  • Set up a retirement account for yourself. Check out SEP IRA or Individual 401k accounts (but don't pay high fees for either of these, TD Ameritrade has a no-fee account and I'm sure there are others). If you start this right away, and put part of each check into it, you won't miss the money. And this can give you a sizable deduction at the end of the year.

  • Set up an emergency fund for yourself. Fund it generously -- 3 months of expenses at a minimum. Contractors are often the first to go when things get tight. (Fortunately, they're also often the first to get hired back.) Keep in mind that you may be forced to relocate to find new work, and as a contractor you won't be reimbursed for these expenses. One of the biggest reasons for having a large emergency fund is that you won't be desperate should you lose your contract unexpectedly. If you know you can survive for a few months without work, you can make sure that your next contract is right for you, and you can have confidence when you're negotiating the rate.

  • Your home office may be deductible if you set it up right. Read the rules carefully.

  • Relocation should be deductible. Again, read the rules. The IRS website has a lot of information. (Some of it is even surprisingly easy to read...)

5) Would it be wise to adjust my consulting rate to compensate for additional taxes, even if cost of living in the new city is lower?

Taxes aren't going to be your only extra expense. Don't forget about:

  • health insurance
  • E+O insurance
  • worker's comp (I've been asked to carry this by clients in the past)
  • tools, equipment, supplies that you may have to buy
  • vacations and sick time are unpaid
  • you may not be eligible for unemployment if your contract is terminated
  • if you decide that forming a company is the right thing for you, you'll have annual fees to the state
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  • 2
    +1 for putting away cash for taxes and also for downtime.
    – Timo Geusch
    Mar 17, 2011 at 16:43
  • 2
    Also remember that over a certain amount you've got (I believe) to send taxes in quarterly, not annually.
    – justkt
    Mar 17, 2011 at 17:15
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    I mentioned estimated taxes above. If you have zero withholding, and you're making any reasonable amount of money, I think you'll have to pay four times a year. Beware of thinking "quarterly", because the dates aren't 90 days apart, I got fooled by this the first time around: Jan, Apr, Jun, Sep.
    – bstpierre
    Mar 17, 2011 at 17:50
  • Is 30% self-withholding enough? FICA taxes alone are almost 15%.
    – stannius
    Sep 17, 2013 at 20:20
  • Something many people fail is understand is that you get more money upfront with contracting. However, the downside is that you'll make quarterly tax payments, and often pay even more with SE tax (in the US).
    – 1234567
    Jun 3, 2017 at 3:13
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There's a lot to think about when setting your hourly rate - benefits, vacation time, etc.

The web calculator I had linked to is dead.

There's a good article about all the things you should consider here:

http://exchangeserverpro.com/how-to-calculate-your-hourly-rate-as-an-it-contractor/

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  • +1 First time I've ever then this type of calculator online
    – Ralph Winters
    Mar 17, 2011 at 14:16
  • Hrmph, calculator doesn't work on Linux. Requires Silverlight plugin.
    – Nick Pickering
    Apr 2, 2013 at 4:37
  • -1 site dead? 404
    – Maslow
    Oct 31, 2013 at 14:40
  • :-( calc is dead. I added a link to an article that gives some guidelines.
    – NPFinance
    Oct 31, 2013 at 14:45
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Since you can't channel the money through the company:2. Your social security tax will double as usually the company pays half of it. 4. I think relocation costs are deductible even if you are full time employee as long as it's more than xx miles. Home office is probably deductible though i've heard IRS really doesn't like that deduction. 5. It's always wise to raise the rate :)

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  • How does your Security Tax double?
    – Ralph Winters
    Mar 17, 2011 at 14:11
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    If you work as an independent contractor, instead of you paying 7.5% of social security/medicare, you will have to pay the full 15%, since the tax law is such that the "employer pays half", and in this case, you are the employer.
    – NPFinance
    Mar 17, 2011 at 14:40

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