Author Topic: Transition to Independent Contractor  (Read 6290 times)

StubbleTrouble

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Transition to Independent Contractor
« on: November 13, 2014, 01:21:11 PM »
Hello fellow mustachians,

I've been a long time lurker and am considering making a fairly big decision and I figured you would be just the right people to ask for some guidance. I currently work for a large engineering firm that has increased the number of contractors it has been hiring. I used to work for a contracting company and I've seen the rates. The aforementioned firm pays up to 3x my current salary for similarly qualified contract workers. So, I've been thinking about transitioning to being an independent contractor.

After some quick research it appears that the best way to go about this is by forming a sole proprietorship. I've done a little bit of research and it appears reasonably cheap and easy to create one. I'd then use the additional wages to cover benefits that the firm currently pays for. The below table shows the percent pay increase I'd need to break even. After some quick back-of-the-napkin calculations that looks like this:

Holidays/PTO: +10%  (11 holidays + 15 days PTO)
End of year Bonus: +10%
401k match: +5%
General Liability Insurance: +25% (Internet indicates that this can range from $500 to $15,000, I chose the $15,000 to be conservative).
Total: +50%

A 50% raise doesn't even come close to the 200% raise I'd (maybe) get from shifting to an independent contractor. I realize being independent might give me less leverage, but even if I only got a 100% raise I'd come out 50% ahead! (Note: I'm 24, so I don't have to worry about health insurance for another 2 years. It appears, however, that I've got plenty of wiggle room to add that in down the line). I also understand that you'd need to add in some opportunity cost for the amount of time spent taking care of things like finding liability insurance, the extra tax implications, etc.   I'm being way too optimistic right? Surely there's something I haven't thought of.

Anyways, the extra independence and money from being an independent contractor sounds great. Additionally, I've mentioned the idea to my boss and he seemed fairly receptive to the idea or at the very least not opposed.   

Would love any thoughts and advice from those of you who have done something similar and can provide a well-measured face-punch to my unrelenting optimism above.

Thanks!

sugarsnap

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Re: Transition to Independent Contractor
« Reply #1 on: November 13, 2014, 01:39:26 PM »
I'm an independent contractor working for a government agency.  It's hard to get raises since it's a whole contract negotiation process. When I started my hourly wage was much higher than a comparable position but I don't get those automatic cost of living, step increases, promotion raises that are pretty automatic for employees. My business liability insurance is about $1200 a year for $1M liability.

There are definite trade offs. It can either be more or less stable depending in unions, etc. during the downturn, the union pretty much forced out contract workers before laying off employees but I was able to come back quicker than the employees as well.


soccerref

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Re: Transition to Independent Contractor
« Reply #2 on: November 13, 2014, 01:56:22 PM »
As a sole proprietor, you will not have the liability protection of a corporate entity.  Consider forming a Limited Liability Company (or whatever formed is permitted in your state of residence).  This will be treated as a pass-through entity for tax purposes.

You should also consider the tax impact of becoming a contractor.  You will be responsible for paying all payroll taxes (15.3%) but may be able to deduct expenses of generating the income. 

frugaliknowit

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Re: Transition to Independent Contractor
« Reply #3 on: November 13, 2014, 02:08:44 PM »
In general, you would need a larger emergency fund to cover yourself "between contacts" as the risk of income gap(s) is generally higher as a contractor.  This is especially the case if you are a one income household. 

StubbleTrouble

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Re: Transition to Independent Contractor
« Reply #4 on: November 13, 2014, 02:14:33 PM »
soccerref: Could you elaborate a bit on the liability protection between an LLC and sole proprietor. My understanding is that's what the business liability insurance is for.

Also, 1200 a year for $1M in liability means I drastically overestimated that cost, we can roll in the payroll taxes (which I do remember reading about but forgot to mention in my original post) and just leave that number at 25% I think, which is still on the conservative side. 

GizmoTX

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Re: Transition to Independent Contractor
« Reply #5 on: November 13, 2014, 02:54:49 PM »
Incorporating as a Sub-S or LLC rather than sole proprietor limits liability to the assets in your business rather than your entire net worth. It's not expensive to do, & also makes you look more professional. Income tax audits happen more to sole proprietors than the incorporated. In any event you need a separate bank account for your business. Depending on what you do, you may not need liability insurance.

You will have double taxes (FICA, FUTA, & maybe state), because the part paid by your employer is assumed to be part of your compensation. An independent contractor pays the employer side as well as the employee side, even if you are the only employee. These taxes must be deposited quarterly in advance.

What about benefits such as health insurance?


StubbleTrouble

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Re: Transition to Independent Contractor
« Reply #6 on: November 13, 2014, 04:04:03 PM »
Health insurance isn't an issue currently since I'm 24 and still on my parents insurance. I've got younger siblings several years away from being independent so it doesn't cost my parents any extra to keep me on their plan.

Sounds like I need to look into the taxes situation a bit more closely, particularly at the state and local levels.

iamadummy

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Re: Transition to Independent Contractor
« Reply #7 on: November 13, 2014, 05:54:44 PM »
Most likely LLC would be the way to go. Cheap and easy to form. 

Wile E. Coyote

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Re: Transition to Independent Contractor
« Reply #8 on: November 13, 2014, 06:20:33 PM »
Does your state require you to have a license to do what you do?  In some cases, if a license is required, you may need to form a professional limited liability company or a professional corporation, and you generally will not be protected from malpractice claims, so you would be wise to have insurance.

mozar

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Re: Transition to Independent Contractor
« Reply #9 on: November 13, 2014, 06:31:32 PM »
I don't know much about engineering, but I know that in many fields it is considered to be less prestigious to be a contractor and you will never be considered for regular full time again. Do you want kids?

Spondulix

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Re: Transition to Independent Contractor
« Reply #10 on: November 13, 2014, 07:35:15 PM »
Liability/malpractice really depends on your field. I was terrified about that the first few years of contracting, but in my field, but no one ever pulls the trigger unless it's something blatantly done in bad faith. Plus, any large firm is probably going to make you sign a contractors agreement, non-disclosure, etc - you're going to get a lot of protection under that.

My accountant has told me multiple times not to go to an LLC until my contractor income is over $125k (or maybe it was $150 - but in that range).

One cost to factor in is your own management/HR/accounting time (this is something a lot of contractors forget). Invoicing and accounting takes time, keeping track of business expenses (if you're going to itemize on your taxes), and the cost of looking for new work (you always have to have your back when you only have one client). I used to have a client that was a large institution and their accountant was awful, so I was having to send duplicate invoices and chase them down for checks. You're turning into a business owner, and not just an employee of it.

Will you need to invest in any equipment? Any technology you will have to maintain to be in compliance with what they need?

Lastly, make sure that your job duty is actually one that can be contractor. Check out the rules on the IRS website. Some employers try to save money by having contractors do the same work, but technically if they are telling you how to do your job or when/where to do it, you are not supposed to be a contractor. If someone reports it and it's found you should be an employee, you might be right back where you started (assuming they can/will hire you back).
« Last Edit: November 13, 2014, 07:58:59 PM by act01 »

Spondulix

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Re: Transition to Independent Contractor
« Reply #11 on: November 13, 2014, 07:57:50 PM »
It's hard to get raises since it's a whole contract negotiation process.
YES - even without a contract it can difficult (or risky) to raise your rates. It's not like you're an employee asking for a raise where they say no and everyone goes back to business. If you suggest a rate increase, and someone else qualified is asking to contract for 2/3 of your current cost, you could be out altogether.

I've had to drop loyal clients because they can't afford to pay more. It takes some getting used to the inconsistency of being a contractor, cause you could be told "we don't need you this week/this month/this project" and really have no notice or say in the matter.

The way you're treated as a contractor (at least in my experience) is much different than when you're an employee. As a contractor, there's no need for loyalty or making sure you're happy. You are viewed as a vendor more than a member of the team. If you mess up or there's a personality conflict, they can just decide not to hire you anymore, and they don't really have to give you notice. As an employee, it can be a lengthy process to fire someone, and you might stick around just for that.

That's not to say don't do it, but the climate is different when you contract. If you have to work from home, that brings up a whole other set of challenges.

Exflyboy

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Re: Transition to Independent Contractor
« Reply #12 on: November 13, 2014, 08:20:52 PM »
Check your State laws about providing "engineering services" or "engineering" if that's what your planning to do.

In Oregon at least that is illegal unless you hold a Professional Engineering license.

In fact even referring to yourself as an "engineer" while not holding a PE license is illegal.. Personally I think that's stupid but the engineering board here is prosecution folks for doing so.

Frank

trialbyFIRE

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Re: Transition to Independent Contractor
« Reply #13 on: March 30, 2016, 09:07:02 AM »
Hi everyone!

Resurrecting this thread as I am in a similar situation... in the financial services industry.

I have only ever been a salaried W-2 employee... if pursuing this route, does anyone have any insight into the rate that should be pursued to come out ahead? With the tax implications and potential benefits my head is already spinning and don't know where to start. I have the feeling the below is simplified because there could be tax benefits of an LLC (which would really reduce the %s listed below to come out ahead?)

Some considerations noted already from OP:
Holidays/PTO: +10%  (11 holidays + 15 days PTO)
End of year Bonus: +10%
401k match: +5%
General Liability Insurance: not sure if this is required in financial services?
Total: +50%

My situation:
- Spouse is employed full-time and while benefits are not great, I can be added onto that health plan
- We can live easily on my spouse's income so I would be able to take the minimum salary needed to avoid scrutiny and not take distributions from the LLC for some time
- Kids in the near future (my current company has decent benefits)


Any input would be greatly appreciated!

Spondulix

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Re: Transition to Independent Contractor
« Reply #14 on: April 02, 2016, 09:08:13 PM »
Funny... when I went freelance the last thing I was thinking about was how to pay myself a 401k match. The things I didn't take into account were the time it takes for things like:
- accounting, sales, marketing, invoicing, etc - business "stuff" that I can't bill the client for
- industry and networking events (especially if it's an out of state convention)
- time/effort to learn new skills, stay on top of technology or law
- being my own runner and assistant. I'm the one running to the post office, picking up lunch, etc
- wear and tear on a vehicle if you need to use it for business
- Covering your own social security taxes (when you're employed they cover the employee portion; self-employed it's coming out of your pocket)

Basically... all the stuff that goes into running a business outside of your actual "job". I'd say 20% above your employee rate at minimum.

protostache

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Re: Transition to Independent Contractor
« Reply #15 on: April 03, 2016, 06:15:59 AM »
- We can live easily on my spouse's income so I would be able to take the minimum salary needed to avoid scrutiny and not take distributions from the LLC for some time

Be aware that you will be paying income taxes on the LLC's income regardless of distributions. If you elect S-corp taxation you get to decide how much SE tax you're paying by setting your salary, but income taxes apply to everything. If you elect C-corp taxation you could theoretically get around it but don't do that without speaking to a CPA first. There are a whole host of caveats and restrictions on closely-held C-corps that don't apply to S-corps or disregarded LLCs.