Author Topic: advice on W2 contracting agency vs Subcontracting in the software industry  (Read 4776 times)

forestj

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Hi all. I have a relatively steady job doing programming/software engineering with a contracting agency. Currently I am a w2 employee, and I get some benefits, like I can easily do a 401k contribution, I get cheap health insurance (they pay half), three weeks paid vacation per year, etc. I like the job well enough, but something is telling me that maybe I can get more money somewhere else.

I recently got an email from a recruiter who works for a subcontracting company, offering a great-sounding $82 an hour -- it sounds like they skim 12% by getting placements for independent contractors and offering some amount of help with setting up an independent contracting company.

After doing a minimal amount of research, I came up with this spreadsheet that shows my estimated comparison of taxes and business costs when working as a W2 employee versus working as sole proprietor LLC doing independent contracting (or sub-contracting as the case may be).

A summary of the differences:

  • Being independent makes you "expendable". Managers might not be as nice to you, and If the project gets cancelled, that means your paycheck gets cancelled.
  • Being independent means you do work that you don't bill for -- marketing, getting contracts, doing your taxes, networking, etc.
  • The revenue would be much greater than my current salary.
  • Due to self-employment taxes, I would pay almost double the social security and medicare.
  • I would have to pay for my own equipment and software licenses -- anywhere from about $1000 to $3000
  • I would have to pay for my own health insurance -- about $2500 - $3000
  • Health insurance, business expenses, and maybe my car, could be deducted from my taxable income, I think?
  • I don't know if I would have access to a 401k or equivalent if I went independent... How does that work?
  • I didn't factor in anything for legal fees or fees associated with starting an LLC, mostly because I don't know if I would need to pay them or how much it would be.  Do I need to hire a lawyer to analyze/negotiate contracts? (I would be subcontracting)



Click here to see it in Google Sheets

Have any of you ever done independent contracting? Did you create an LLC or S-Corp to do it? If so, how did you handle your taxes and contracts ?  Do my calculations look correct?  What was your experience, and what would you recommend?

I have a few colleagues that I can ask about this, but I thought I would pose the question to the mustache-verse as well, as I am looking at this from the early retirement perspective.
« Last Edit: March 03, 2016, 12:16:15 AM by forestj »

caracarn

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I get that it is $10 per hour more in your calculation, which is certainly nothing to sneeze at, but for me at least the uncertainties of finding work as an independent make the risk and down sides greater.  I think you would need to do a SEPP based 401(k) (I may have the terminology wrong) as an independent and that has a much higher contribution limit (I think I saw something like $50K on an MMM article discussing it). 

I have found over years in looking at the various models in IT that, just like anything else in life, there is no such thing as a free lunch.  If it seems too good to be true, it always is. The higher billing rate as an independent is, as your math proves out, only an offset to higher costs you incur on self employment taxes and insurance.  Yes you can also then deduct much more as business expense.  This all increases your time keeping records and the complexity of your taxes.  It is also meant to cover the uncertainty of work, which you did note with a 9 week higher "unemployment" period than your current configuration.  What if it turns out to be 26 weeks instead of 40 because you can only find a 6-month contract?  Now you are well under your current process.  On the other hand, if you can establish a great client base (most people take 2-4 years to do that, during which time they can be very lean indeed) your income can greatly increase, however you are still limited by the finite reality that you can only work on one job at a time so there are only 52 weeks in a year so you then can look at adding employees and forming your own contracting company and taking a portion of their income (the 12% skim you refer to) but that takes additional work etc.  Those are come of the things I would consider, including if you really enjoy all that other admin work, which is not programming.

TheAnonOne

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$82/hour is exactly what I get paid as a W2 contract worker. I made a bit over $200,000 last year after a bit of overtime. I also took 3 weeks off, just made up the time.

Wife covers all my medical and other stuff. <- it's a sweet deal

If you want to do consulting, get in the mindset, put in the hours, learn to say yes to every additional hour.

//my $.02

TheAnonOne

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The biggest benefit to creating an S-Corp for yourself is the Solo-401k with a federal max input of over $50 grand tax free.

You can also pay yourself a "reasonable" wage and take the rest as a distribution. You avoid a bit of 'payroll' taxes that way. *NOTE: not income taxs*

As a W2 you can still deduct things like mileage, though, sometimes to a lesser degree.

forestj

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$82/hour is exactly what I get paid as a W2 contract worker. I made a bit over $200,000 last year after a bit of overtime. I also took 3 weeks off, just made up the time.

Where do you work (geographically) and how long have you been doing it? Any industry or tool specialization? That sounds like an awful lot to me.

What if it turns out to be 26 weeks instead of 40 because you can only find a 6-month contract?

This is the kind of stuff that really worries me. I know for a fact that I can continue to slowly grow my salary at my current gig, and I consider my time-to-FIRE of about 5 years to be acceptable, not great, but acceptable. I think I might rather look for the FTE route in a senior position somewhere, which might get me about $125,000 / a year. (I live in a relatively LCOL area).

The self-directed 401k or SEPP, with contribution limit of 50k, sounds awesome though -- I would love to be able to contribute more pre-tax money to my current 401k, and doing so would bump up my post-tax earnings another ~10k per year.

I'm just not sure if I am ready for all the extra administrative work and risk. I definitely don't want to end up investing years into this before it pays off, and doing it as a career (farming out the programming to others), it's not my cup of tea..

I'm planning on FIRE first on a meager sum, then the "real" work starts, which would be FLOSS development and / or startups and creating products without having to worry about getting paid. I think that's what I really want.
« Last Edit: March 03, 2016, 01:56:54 PM by forestj »

TheAnonOne

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$82/hour is exactly what I get paid as a W2 contract worker. I made a bit over $200,000 last year after a bit of overtime. I also took 3 weeks off, just made up the time.

Where do you work (geographically) and how long have you been doing it? Any industry or tool specialization? That sounds like an awful lot to me.


.NET mainly, (along with quite a few surrounding tools...) in the Midwest.

Assuming you put in 2080 hours (making up any time off but working 0 overtime) your income would be $170,560.

I have not had any time off in-between clients in 6 years.

TheAnonOne

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I replied to your PM.

That being said, is the quoted rate of $82/hour as a CORP-CORP or as a W2 Hourly? There is a huge difference. (W2 hourly being better for you)

I see your quoted rate is CORP/CORP. You could also sign up under this firm as a W2 hourly, the quoted rate will go down about 7% to account for extra taxes. My quoted rate was $82 as a W2H so... about $88-$90 as a C2C (for apples to apples)

My firm also has a 401k, so I get the 18k deduction along with the higher hourly pay. There are no vacation weeks, or other benefits though. (they do offer health @ 1/2 cost)

The point of mentioning it is that, simply because you are going to a contract/consultant role, does not mean you are giving up all the benefits guaranteed. Sometimes, these firms will have some benefits and a 401k. Though usually no match.

You are correct in assuming that the risk is higher in hourly work, though, I find that the experience you gain, and the pay, more than make up for it.

Looking at your numbers above (which are conservative on the hourly side, your accounting for a gigantic amount of time off) you could have weeks or months in between clients and still match the overall pay of being salaried. Add those 7 weeks off back in (or 5 to give yourself 2 weeks off) and the pay gap rises even more. If they offer OT and you take it, the gap becomes laughable. IMO: working salary isn't worth it in this industry unless you really value sticking with one company.
« Last Edit: March 04, 2016, 12:11:14 PM by TheAnonOne »

Axecleaver

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I wanted to address some of your misconceptions about being an independent contractor in IT. I have been doing it since 1996. The corp to corp rate you were quoted doesn't account for FICA taxes. Most firms will give you a W2 rate and a c2c or 1099 rate. The 1099 rate should be about 10% higher. They have additional expenses you won't, namely unemployment, worker's comp, and liability insurance. Some firms will also quote you "all inclusive" rates which require you to pay for travel. This can be a great boon if you manage your travel carefully. I usually estimate 35-40/h for a 40 hour week requiring air travel, but every city is a bit different.

1. Being independent makes you "expendable". Managers might not be as nice to you, and If the project gets cancelled, that means your paycheck gets cancelled.
No, it doesn't. You're already working for a body shop, you're expendable as a W2. The "safety" of a full time job is an illusion. Companies will drop you in a new york minute, and don't forget it. The only safety in the modern economy is in maintaining your marketable skills.

2. Being independent means you do work that you don't bill for -- marketing, getting contracts, doing your taxes, networking, etc.
This is true, but if you're not doing most of this for your W2 career, you're making a big mistake. It's true that you have to do a little extra work on maintaining a pipeline, contract management, etc.

3. The revenue would be much greater than my current salary.
This is why most of us do it :).

4. Due to self-employment taxes, I would pay almost double the social security and medicare.
Sure, but you get a self employed credit of half of that back.

5. I would have to pay for my own equipment and software licenses -- anywhere from about $1000 to $3000
I would have to pay for my own health insurance -- about $2500 - $3000
Yep.

6. Health insurance, business expenses, and maybe my car, could be deducted from my taxable income, I think?
Health insurance premiums are fully deductible if you're self employed. Check out this thread for business expenses: http://forum.mrmoneymustache.com/reader-recommendations/freelance-resources/msg1000195
For your car, you can deduct mileage. There are some gotchas to watch out for - keep a written mileage log and track the mileage of your car for personal use, you have to report that as well.

7. I don't know if I would have access to a 401k or equivalent if I went independent... How does that work?
You can open a SEP-IRA or Solo-k which allows up to $53k a year in contributions. There are some good posts on that here.

8. I didn't factor in anything for legal fees or fees associated with starting an LLC, mostly because I don't know if I would need to pay them or how much it would be. 
My opinion is that an LLC is not worth it for software development. Create an S-corp and if you're worried about professional liability, buy liability insurance. I created an LLC in 1996 and wish I had done it as an S-corp.

9. Do I need to hire a lawyer to analyze/negotiate contracts? (I would be subcontracting)
Until you get some experience, I recommend you do. You sound very inexperienced and some contractual issues around limited liability and flowdowns from master contracts are A Big Deal. I handle most of this myself now, but I've been doing it a long time. I also know when it's time to call my lawyer and have him look at something.

The other thing I didn't see you address is payment terms. Typically independents are on a net-30 monthly payment schedule. So let's say you work March 1-March 31, you invoice on Apr 1 for March hours. The payment is due on Apr 30. That means that if the payment is on time, you have to bridge 60 days before you get paid. And most payments are not on time. Most of my clients pay in the net 45-ish range.

TheAnonOne

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The other thing I didn't see you address is payment terms. Typically independents are on a net-30 monthly payment schedule. So let's say you work March 1-March 31, you invoice on Apr 1 for March hours. The payment is due on Apr 30. That means that if the payment is on time, you have to bridge 60 days before you get paid. And most payments are not on time. Most of my clients pay in the net 45-ish range.

Our firm sees a few NET90 terms as well. . . These are a bit rarer but sometimes you can get a higher rate for this.

forestj

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 I just got the "how to be independent" quick guide from the subcontracting company that's trying to recruit me.  Here are some things they listed:

There are 4 ways to run an independent consulting business:

Sole Proprietorship
Partnership
LLC
Corporation

They said they only work with LLCs and Corporations for liability reasons.  It sounds to me like if you are doing business as a legal business entity then there are slippery ways you can avoid liability. Like your business goes bankrupt but you don't, for example.  Interesting.

They said that they require me to hold $1M general liability business insurance, which would have a premium of about $400/year.

They said that I might need to acquire a state tax ID, state unemployment insurance and state workers comp insurance for the state I live in.

I don't think this subcontracting company offers W2 employment. I could try to go around them and go direct to the prospective client for a W2. But I don't know what they would offer -- if it was %10 less than the $82/hr 1099 offer, I would jump at the chance.



I wanted to address some of your misconceptions about being an independent contractor in IT. I have been doing it since 1996. The corp to corp rate you were quoted doesn't account for FICA taxes.

1. Being independent makes you "expendable". ...
No, it doesn't.  You're already working for a body shop, ...

Well, maybe not expendable. But it its a different relationship, and I think it would be a relationship more likely to end?

The firm I work for now has at least 10 current clients, and average time spent on bench is about 10% of the year. They love me because even if I'm on the bench right now, they still will make a bundle of $$$$ from me this year. I'm not certain I could match that 10% time on bench if I was fully independent.  They would hate to be called a "body shop" hehe. They do try, bless their hearts...   I realize they are probably  taking advantage of me (even though the experience I have gotten has been great for career growth.)  That's why I am looking into this in the first place.
 
9. Do I need to hire a lawyer to analyze/negotiate contracts?
Until you get some experience, I recommend you do. You sound very inexperienced and some contractual issues around limited liability and flowdowns from master contracts are A Big Deal. I handle most of this myself now, but I've been doing it a long time. I also know when it's time to call my lawyer and have him look at something.

Yes, I am inexperienced, I've never done it before :). How should I go about finding someone to do this? How much does it usually cost?  I can ask some of my colleagues who are independent contractors, but I'm curious to hear what yall mustachios have to say as well.

Typically independents are on a net-30 monthly payment schedule. So let's say you work March 1-March 31, you invoice on Apr 1 for March hours. The payment is due on Apr 30. That means that if the payment is on time, you have to bridge 60 days before you get paid. And most payments are not on time. Most of my clients pay in the net 45-ish range.

I wont have any trouble bridging, but have any of ya'll ever had problems collecting the money that a company agreed to pay you? especially if it was a large company, since the client in question is huge retail corporation. What about through a sub-contract?


Thanks for all the info everyone.  I really appreciate it :)
« Last Edit: March 04, 2016, 10:16:17 PM by forestj »

Axecleaver

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I've had trouble collecting from middle men before. One went bankrupt after they took money from the end-client, and chose not to give me what I was owed. I lost about $15k in services wages. Went through bankruptcy proceedings and spent some time and money on legal fees, in the end I barely got enough to cover the lawyer. Was not a pleasant experience.

Another time the middleman refused to pay, I went straight to the end client. They fired them a few weeks later for breach(their contract specifies they have to pay their subs within a certain period of time), the client went out of their way to make me whole, and I got a higher ongoing rate for my trouble. Still took a while to work its way through the process, so having an emergency fund is key to making this work.

Giro

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I've been considering this for myself for quite some time, so I'm glad you started this post.

With a 10% hike in salary, putting $53k in my 401, I would pay less in taxes and be making more money.  It's a win/win for me.  I don't need health insurance or benefits.

I may go to my employer and ask about this.  I know in the past, they didn't want me hiring 1099 employees but it can't hurt to ask. 

bacchi

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You need to earn $140k to max out the solo 401k.

Companies don't like straight-up 1099 workers because they can't require them to sit at a desk or work during normal business hours. The tasks have to be independent enough for the worker to more-or-less get the requirements, work on it at home from 7-11pm, and turn in the results a week later. Think of it like hiring an electrician to rewire your house. Electricians don't show up at 9am for status meetings and they may take a long lunch or even not show up for the day. Electricians don't ask the homeowner's permission to leave work work early.

There's some wink-wink nudge-nudge around 1099 jobs and IT. You'll have to decide how much you want to push it, with the realization that you do have a trump card (see IRS form SS-8). At the very least, tell rather than ask about your time off. If the meetings are worthless, avoid them. Occasionally exercise your power to work from home.

Giro

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You need to earn $140k to max out the solo 401k.

Companies don't like straight-up 1099 workers because they can't require them to sit at a desk or work during normal business hours. The tasks have to be independent enough for the worker to more-or-less get the requirements, work on it at home from 7-11pm, and turn in the results a week later. Think of it like hiring an electrician to rewire your house. Electricians don't show up at 9am for status meetings and they may take a long lunch or even not show up for the day. Electricians don't ask the homeowner's permission to leave work work early.

There's some wink-wink nudge-nudge around 1099 jobs and IT. You'll have to decide how much you want to push it, with the realization that you do have a trump card (see IRS form SS-8). At the very least, tell rather than ask about your time off. If the meetings are worthless, avoid them. Occasionally exercise your power to work from home.

I'm fine with a negotiated schedule with hours.  I would be in the same building working at the same desk and everything.  It shouldn't change anything since we have other sub-contractors working for us.  I would basically be a sub to the company instead of an employee.  I'll lose my vacation/holiday pay but I added that into my calculation. 

I was also thinking instead of salary, I would have an hourly rate.  That would protect them even more.  I don't know if they'll go for it, but I want to ask.  It's very much worth it.  I'm looking at $15k more a year.

forestj

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I'm in the process of talking to my current employer about the non-compete I'm under, and gonna talk to a lawyer about it too, unless it goes really well. I have gotten a recommendation from an experienced colleague that the subcontracting company that I would be working with is good stuff. It's nice to hear from what is essentially the horse's mouth.