How to calculate self-employed income equivalent to employee pay?

March 1, 2013 9:52 AM

I know the self-employed in the US face a strange tax situation. Now think of the salary + benefits of a full-time employee position. How much more money would you have to be paid, as a self-employed independent contractor, to get the after-tax equivalent of that salary, assuming you then had to purchase the benefits yourself?
posted by shivohum to work & money (11 answers total)

There's no definitive answer to this question other than "it depends". Which tax bracket someone falls into, the specifics of the benefit package in terms of health insurance costs versus how much that particular insurance would cost on the private market (taking any preexisting health issues into account, and general demographics in terms of gender, age, smoking/nonsmoking, whether or not it's a family plan or individual, and so on).

As a general rule of thumb as a self contractor you'd want to put around 1/3 of your income aside for taxes.
posted by reptile at 9:59 AM on March 1 [2 favorites]

There's no hard-and-fast way to calculate this, because employer benefits can vary widely.

However, we can throw some numbers at a wall and see if they stick.

Let's say that you're making a nominal $50K.

If you're a freelancer, you'll be paying $6100 in self-employment taxes (social security + medicare taxes) that a W2 employee would not pay.

If you're a W2 employee, you're probably getting some kind of a healthcare plan. If we value this at whatever you'd need to pay on the open market to get comparable individual coverage, this could be worth anywhere from, say, $3000/yr (for "don't get sick" insurance for a young person in good health) up to a very high amount indeed.

So we're at a minimum of about $9000 advantage for the W2 employee making $50K.

You could add to that employer-sponsored retirement plans, employer contributions to your own retirement plan, matching funds for charitable contributions, employer-sponsored training, etc. Depending on the quality of benefits, non-wage compensation can be roughly equal to direct wage compensation.
posted by adamrice at 10:04 AM on March 1

Yeah, it really depends on a lot of factors, but if you want a real-world example, I just added up all of the contributions (employee + employer) for taxes, retirement, medical insurance, dental insurance, and FSA and it is about 72% of my salary ($2734.76 pay, $1996.23 taxes/insurance/retirement, this is for a bimonthly paycheck, so double that amount for a month's worth of benefits: $3992.46).

And that's with group rates -- it's kind of shocking how expensive health care is these days. And that's not even counting sick and vacation leave time, which is not counted as a dollar amount but just expressed as a number of hours in a leave bank.

So you (or rather, I, since this is only one example) would have to be earning at least twice as much to get the same benefits.

(City employee with BCBS health, a dental HMO, and Oregon PERS retirement)
posted by rabbitrabbit at 10:13 AM on March 1

It depends heavily - especially because of the variability of buying your own health insurance. People who have a spouse whose health insurance can cover them have a much, much easier time. Plus, very few self-employed people have a super-reliable income stream, so there's usually an added amount to buffer for lean months.

But the quick-and-dirty, gun-to-your-head-get-a-number-now rule of thumb is "Twice as much."
posted by Tomorrowful at 10:16 AM on March 1

How much more money would you have to be paid, as a self-employed independent contractor, to get the after-tax equivalent of that salary, assuming you then had to purchase the benefits yourself?

I am currently an independent contractor. If I moved to an employee position with equivalent health insurance, a reasonable retirement plan, and a reasonable amount of paid vacation, I could take about a 25% pay cut and feel approximately equally well compensated.

But I am a young, healthy male with no dependents, so my health insurance is cheap.
posted by jedicus at 10:22 AM on March 1

I just realized that I can actually express vacation and sick leave as a dollar amount. Add $7308 per year for leave time.

So for my example:

Annual salary: $65,634.24
Annual cost of benefits: $55,217.52
(3992.46 * 12 for taxes/retirement/insurance, plus $7308 for leave time)

So yeah, in my example, add 84% for benefits.
posted by rabbitrabbit at 10:24 AM on March 1

Take the salary. Double it. (That's 50% for the benefits and taxes you now have to pay for yourself, another 50% for the work you have to do that doesn't pay you directly, such as bookkeeping and client acquisition, and because you probably won't be working all the time, at least at first). Divide by 2000 for your target hourly rate. This gives you room to give discounts for prompt payment, steady work, clients you particularly like, etc.
posted by kindall at 10:31 AM on March 1 [2 favorites]

One rule of thumb is this: hourly rate = 1.5 * ( full-time annual salary / 2000 )
posted by Houstonian at 12:15 PM on March 1

I agree with somewhere between 1.5 and 2 * your effective hourly rate as a payroll employee.

Like others said, much depends on the details. If I knew I could bill 40 hours/week on a steady basis, I'd be more comfortable with the lower end of that range. If it was a one off gig and I was obviously the best guy for the job (frex a project for a former employer) I'd want more than 2*n.
posted by mattu at 12:57 PM on March 1

Just don't think about it too much. Divide by $1000. If you'd make $86k full time with benefits, your hourly rate is $86.

This might seem like a lot and people may try to divide by two when negotiating while showing fancy math based on hours and calendars, but they are trying to get you cheap. It costs a lot for a company to have full time employees. Plus they are paying for the ability to keep you at arms length which is worth something for them and is not a benefit for you, so you should get compensated for it.
posted by cmm at 12:58 PM on March 1

In ~2002 I worked for a start-up that had some government contracts. The contracts were negotiated not-for-profit, but rather closely related and thus an aid to our R&D. The dictated number was:

federal reimbursement rate for government contracts = 1.77*hourly rate

A year later I later I left the company but continued to do occasional contract work. I used this formula to determine my contract rate to the same company... It was grudgingly accepted.
posted by tinker at 2:07 PM on March 1