What's the best employment model for my boss to pay me?
February 19, 2022 9:50 AM Subscribe
For 6 months I've done 10 hr/wk contract job for a local consultant / freelancer. He's starting his own business and wants to bring me in as his first (probably only) full time employee. What's the best way for us to do this - w2, 1099, retainer, etc?
I quite like the work and could see myself being more than willing to work above 40 hours a week, but probably not 55. At the same time, I'm anxious about filling all my hours with billable work - in my corporate life, 10-20% of my time was spent on trying to figure out what to do, networking, coffee breaks etc. We both want to find the best way to structure this, to reduce admin overhead, anxiety over hours worked, and focus on building this business.
I also want to have about 25 days of "pto" for vacation, holiday, sick days etc, which is what my spouse has. For the sake of calculations, let's assume I work (52 wks x 40 hrs) - (25 days x 8 hrs) = 1,880 hrs/year.
For round numbers sake, let's say I am trying to get 50k after tax, almost no expenses (maybe a new laptop and some software), and health insurance through my spouse.
I also want to have about 25 days of "pto" for vacation, holiday, sick days etc, which is what my spouse has. For the sake of calculating net after tax and after vacation pay, let's say I work (52 wks x 40 hrs) - (25 days x 8 hrs) = 1,880 hrs/year
Taxes include, I think, 24% income tax, 5% state and local tax, 15% self-employment tax = 45% tax rate. If I'm w2 employee, we split the self-employment tax, but I'm not sure why it it costs $4k more to pay self employment tax than payroll tax. Residing in Michigan, USA. Fuzzy math is just fine, though. And, my partner earns about 30k, for tax bracket calculation purposes.
I think the options are:
1. He takes me on as a w2 employee with around $62k salary. I pay 12k tax, he pays 5k tax. Total cost, $67k. No fussing with hours, pto, etc.
2. He takes me on as an hourly employee at $30/hr with 25 days pto. I track hours and earn overtime. Should be same taxes as above. This seems like more work for us, but it might be safer for his new business to be tracking my hours on a weekly basis.
3. 1099 contractor at $38/hr. Total cost, $72k. I pay $22k taxes. This seems more expensive for the business, but then the business doesn't have to do payroll and taxes.
4. Retainer model with flat rate of $1,300 / wk. Taxes same as above, but no need for invoicing, tracking hours, etc. However, I wonder if this is employment law grey area?
Can you please help us understand the pros and cons of these different options?
I quite like the work and could see myself being more than willing to work above 40 hours a week, but probably not 55. At the same time, I'm anxious about filling all my hours with billable work - in my corporate life, 10-20% of my time was spent on trying to figure out what to do, networking, coffee breaks etc. We both want to find the best way to structure this, to reduce admin overhead, anxiety over hours worked, and focus on building this business.
I also want to have about 25 days of "pto" for vacation, holiday, sick days etc, which is what my spouse has. For the sake of calculations, let's assume I work (52 wks x 40 hrs) - (25 days x 8 hrs) = 1,880 hrs/year.
For round numbers sake, let's say I am trying to get 50k after tax, almost no expenses (maybe a new laptop and some software), and health insurance through my spouse.
I also want to have about 25 days of "pto" for vacation, holiday, sick days etc, which is what my spouse has. For the sake of calculating net after tax and after vacation pay, let's say I work (52 wks x 40 hrs) - (25 days x 8 hrs) = 1,880 hrs/year
Taxes include, I think, 24% income tax, 5% state and local tax, 15% self-employment tax = 45% tax rate. If I'm w2 employee, we split the self-employment tax, but I'm not sure why it it costs $4k more to pay self employment tax than payroll tax. Residing in Michigan, USA. Fuzzy math is just fine, though. And, my partner earns about 30k, for tax bracket calculation purposes.
I think the options are:
1. He takes me on as a w2 employee with around $62k salary. I pay 12k tax, he pays 5k tax. Total cost, $67k. No fussing with hours, pto, etc.
2. He takes me on as an hourly employee at $30/hr with 25 days pto. I track hours and earn overtime. Should be same taxes as above. This seems like more work for us, but it might be safer for his new business to be tracking my hours on a weekly basis.
3. 1099 contractor at $38/hr. Total cost, $72k. I pay $22k taxes. This seems more expensive for the business, but then the business doesn't have to do payroll and taxes.
4. Retainer model with flat rate of $1,300 / wk. Taxes same as above, but no need for invoicing, tracking hours, etc. However, I wonder if this is employment law grey area?
Can you please help us understand the pros and cons of these different options?
Response by poster: Not so much, unless there would be a way to structure that so the "expense" of my headcount is reduced while maintaining the target post-tax income, from which I would plan to put 25% into a retirement vehicle.
posted by rebent at 10:40 AM on February 19, 2022
posted by rebent at 10:40 AM on February 19, 2022
IANA Tax Expert.
There is some good info from the IRS here. One thing you (or, more specifically, your employer) want to be sure of is that you aren't misclassified as a 1099 when you really should be a W2. The employer can face fines and penalties for this. There is actually a form SS-8 you can file and the IRS will actually tell you what you should be classified as based on the answers to the questions in the form.
It seems, from reading this page, that this isn't so much a choice as it is acting on the interpretation of the IRS rules and requirements (which still seem to result in somewhat of a grey area depending on your specific situation).
Your state may also have specific guidelines as well. You may benefit from reaching out to your state's Department of Labor and Industry or equivalent and/or a local employment attorney.
posted by SquidLips at 11:07 AM on February 19, 2022 [4 favorites]
There is some good info from the IRS here. One thing you (or, more specifically, your employer) want to be sure of is that you aren't misclassified as a 1099 when you really should be a W2. The employer can face fines and penalties for this. There is actually a form SS-8 you can file and the IRS will actually tell you what you should be classified as based on the answers to the questions in the form.
It seems, from reading this page, that this isn't so much a choice as it is acting on the interpretation of the IRS rules and requirements (which still seem to result in somewhat of a grey area depending on your specific situation).
Your state may also have specific guidelines as well. You may benefit from reaching out to your state's Department of Labor and Industry or equivalent and/or a local employment attorney.
posted by SquidLips at 11:07 AM on February 19, 2022 [4 favorites]
Depending on the nature of the work you are doing, it may be illegal for him to pay you as a contractor. Lots of people break that, but it exists for a reason. The details of the rules vary from state to state.
If you are a W2 employee you will qualify for unemployment insurance if you get laid off. Contractors do not generally have access to unemployment insurance (pandemic emergency being a one-time exceptional situation).
Being a W2 employee will also simplify your life, and reduce the chances of you spending money that you should be setting aside for taxes.
Unless you have a specific reason you want to be a contractor -- e.g. you plan to offer your services to other companies -- I would encourage you to be a W2 employee.
posted by Winnie the Proust at 11:12 AM on February 19, 2022 [5 favorites]
If you are a W2 employee you will qualify for unemployment insurance if you get laid off. Contractors do not generally have access to unemployment insurance (pandemic emergency being a one-time exceptional situation).
Being a W2 employee will also simplify your life, and reduce the chances of you spending money that you should be setting aside for taxes.
Unless you have a specific reason you want to be a contractor -- e.g. you plan to offer your services to other companies -- I would encourage you to be a W2 employee.
posted by Winnie the Proust at 11:12 AM on February 19, 2022 [5 favorites]
Does any of this include health insurance benefits? Since you're the only employee, maybe not, but -- consider whether your spouse might want to have the freedom to go freelance/lose benefits (assuming you get benefits through your spouse now).
posted by amtho at 11:12 AM on February 19, 2022
posted by amtho at 11:12 AM on February 19, 2022
One angle to consider, as the worker, is how much certainty there is of regular work and regular income between the three options, and what benefits there are (if any) if the business owner wants or needs to stop paying you for work. Usually the price point for contract work includes a premium that covers the overhead of the contractor needing to spend some fraction of their time on unbillable activities such as lining up their next paid contract -- similarly the business owner gets the benefit of more flexibility of not being locked in to the longer term financial liabilities and responsibilities to their employees, being able to end a short-term contract if their business has cash flow problems or cancels a project, etc.
But this will depend pretty heavily on local employment law, and i'm not familiar with how it works in the US or Michigan.
Given this is a brand new business venture, arguably there is substantially higher risk that the business might fail -- compared to an established business -- so there might not be much certainty of continuing work and income as a salaried employee.
posted by are-coral-made at 11:15 AM on February 19, 2022
But this will depend pretty heavily on local employment law, and i'm not familiar with how it works in the US or Michigan.
Given this is a brand new business venture, arguably there is substantially higher risk that the business might fail -- compared to an established business -- so there might not be much certainty of continuing work and income as a salaried employee.
posted by are-coral-made at 11:15 AM on February 19, 2022
If you're on a 1099 basis, you're not an employee, you're a contractor.
SquidLips makes an important point. A converse point is that you can deduct any business expenses you incur on a 1099 basis, but not on a W2 basis. So if you buy (say) a new computer, standing desk, what have you, and it's specifically for your work, you can only take that as a deduction if you're 1099. If you're W2 and your employer buys it for you, the employer can take the deduction. But if you're W2 and you buy something for performing your job, you cannot take that as a deduction.
As I understand it, if you're employed at least 30 hours/week with this guy, he must offer you health insurance. That alone will probably make W2 the more expensive option for him.
Retainer fees are nice because you can get paid for not working. You can do this on a basis where you're paid a lower retainer fee, and all the work you do up to that amount is covered by it, but after that you bill hourly. This is a way of the client reserving a certain amount of your time.
posted by adamrice at 11:20 AM on February 19, 2022
SquidLips makes an important point. A converse point is that you can deduct any business expenses you incur on a 1099 basis, but not on a W2 basis. So if you buy (say) a new computer, standing desk, what have you, and it's specifically for your work, you can only take that as a deduction if you're 1099. If you're W2 and your employer buys it for you, the employer can take the deduction. But if you're W2 and you buy something for performing your job, you cannot take that as a deduction.
As I understand it, if you're employed at least 30 hours/week with this guy, he must offer you health insurance. That alone will probably make W2 the more expensive option for him.
Retainer fees are nice because you can get paid for not working. You can do this on a basis where you're paid a lower retainer fee, and all the work you do up to that amount is covered by it, but after that you bill hourly. This is a way of the client reserving a certain amount of your time.
posted by adamrice at 11:20 AM on February 19, 2022
Also, with regard to the salaried option: Just because you are salaried doesn't automatically mean there is automatically "no fussing with hours / PTO". There are sub-classifications to Salaried employees: Exempt vs. Non-Exempt. While there a number of subtle differences, one of the key factors is that the latter is eligible for overtime pay when working over 40 hours/week. And PTO is an employer choice. There are certainly employers out there who take an "as much PTO as your manager allows you to take" approach, but it's much more common to have a set limit. It's an employer preference, but it's something to think about and ensure you have clarity on so you don't end up not getting hosed on it down the line.
posted by SquidLips at 11:22 AM on February 19, 2022 [1 favorite]
posted by SquidLips at 11:22 AM on February 19, 2022 [1 favorite]
Best answer: If I were you I'd want to be W2 because it would make me feel like I truly was an employee, not just a contractor that can be easily let go if things don't work out. It just "feels" more concrete to me. In fact, I would negotiate for a very small stake in the company to be part of comp. Like 1% of the company per year until a maximum of 5 years or something.
Large enough that you feel valued and motivated, but small enough where you aren't working only for equity. That sounds like a lot more fun of an arrangement to me.
posted by bbqturtle at 11:25 AM on February 19, 2022 [1 favorite]
Large enough that you feel valued and motivated, but small enough where you aren't working only for equity. That sounds like a lot more fun of an arrangement to me.
posted by bbqturtle at 11:25 AM on February 19, 2022 [1 favorite]
> negotiate for a very small stake in the company to be part of comp. Like 1% of the company per year until a maximum of 5 years or something.
yeah, i was wondering about this as well. trying to figure out a fair price for equity in a new business is a can of worms, e.g. most new businesses will fail and the equity will be worthless, if you want to sell it then there won't be a liquid market where you can sell it for a fair price even if it is worth something, etc. there's also plenty of ways that a majority shareholder with control of the company can screw over minority shareholders -- some legal, some illegal --- maybe the current business owner wouldn't do that, but at some point they might sell to new owners.
one way i've seen people frame it is to suggest not regarding equity in a new business as part of the compensation package, but regarding it more as one mechanism that the business can use to help retain experienced staff in the longer run, and to help align interests for the success of the business. so dont accept less cash for equity.
for more detail about the failure modes and valuation of startup options as an employee, see: Dan Luu's startup options vs cash
posted by are-coral-made at 11:37 AM on February 19, 2022 [1 favorite]
yeah, i was wondering about this as well. trying to figure out a fair price for equity in a new business is a can of worms, e.g. most new businesses will fail and the equity will be worthless, if you want to sell it then there won't be a liquid market where you can sell it for a fair price even if it is worth something, etc. there's also plenty of ways that a majority shareholder with control of the company can screw over minority shareholders -- some legal, some illegal --- maybe the current business owner wouldn't do that, but at some point they might sell to new owners.
one way i've seen people frame it is to suggest not regarding equity in a new business as part of the compensation package, but regarding it more as one mechanism that the business can use to help retain experienced staff in the longer run, and to help align interests for the success of the business. so dont accept less cash for equity.
for more detail about the failure modes and valuation of startup options as an employee, see: Dan Luu's startup options vs cash
posted by are-coral-made at 11:37 AM on February 19, 2022 [1 favorite]
As a number of people have already said, this is less of a choice than it is about classifying your employment correctly. Both as W-2 versus contractor, and if you are W-2, exempt versus non-exempt for overtime.
posted by augustimagination at 12:11 PM on February 19, 2022
posted by augustimagination at 12:11 PM on February 19, 2022
Others have already mentioned the fact that contractor vs. employee status is determined by the IRS based on specific criteria -- it's not up to you and your employer alone to make that call.
I'd also note that salaried vs. hourly status is also regulated by a federal law called the FLSA. In order to be salaried, (1) your duties must meet certain criteria, and (2) your salary must meet a specific weekly minimum. Here's a good fact sheet on the federal FLSA. I'm not sure if Michigan has a separate/higher requirement; the phrase you'd need to look for is "michigan exempt salary threshold 2022".
posted by ourobouros at 1:04 PM on February 19, 2022 [1 favorite]
I'd also note that salaried vs. hourly status is also regulated by a federal law called the FLSA. In order to be salaried, (1) your duties must meet certain criteria, and (2) your salary must meet a specific weekly minimum. Here's a good fact sheet on the federal FLSA. I'm not sure if Michigan has a separate/higher requirement; the phrase you'd need to look for is "michigan exempt salary threshold 2022".
posted by ourobouros at 1:04 PM on February 19, 2022 [1 favorite]
Response by poster: Wow, I'm surprised I'm so off base on this. I figured that, because there is so much gray area that there would be flexibility. For example, I don't want health insurance, nor do I worry about overtime pay.
posted by rebent at 1:50 PM on February 19, 2022
posted by rebent at 1:50 PM on February 19, 2022
Response by poster: Sorry to double post, but this website makes me think I should be an independent contractor.
posted by rebent at 2:03 PM on February 19, 2022
posted by rebent at 2:03 PM on February 19, 2022
There was a lot of abuse of the system where large employers were treating people as contractors to avoid the protections that would be given to employees as the law was tightened up. Some statues, especially California, are even stricter.
If your role fits that of an exempt employee (which seems likely) then you can still negotiate the benefits package to make it fit your mutual needs. Just read up a little on how employers deal with PTO for exempt employees. In larger companies, you get a fixed amount that you can use in half-day or whole day increments (anything less, expected you will just balance it out over the course of the week) Without any other agreement I think (not expert) that employer doesn't have to pay for a week where you don't work any hours - not that your friend would do that but it means that you would want to put whatever agree upon in writing.
posted by metahawk at 2:09 PM on February 19, 2022 [1 favorite]
If your role fits that of an exempt employee (which seems likely) then you can still negotiate the benefits package to make it fit your mutual needs. Just read up a little on how employers deal with PTO for exempt employees. In larger companies, you get a fixed amount that you can use in half-day or whole day increments (anything less, expected you will just balance it out over the course of the week) Without any other agreement I think (not expert) that employer doesn't have to pay for a week where you don't work any hours - not that your friend would do that but it means that you would want to put whatever agree upon in writing.
posted by metahawk at 2:09 PM on February 19, 2022 [1 favorite]
Best answer: Don't rely on that website - it is only looking at part of the picture!
Here is the what the IRS says.
If your friend just gives you a project and expects you to deal with it, with progress reports along the way, then you look more like an independent contractor (on the federal level, in California I know there are additional tests regarding the relationship of your work to the core products of the company)
If you are clearly in the business of being a contractor, work with other clients, pay for your basic business expenses (computer, internet, whatever) then you look more like an independent contractor.
If you are working full time for one organization, if you are working as an integral part of a team with lots of feedback flowing back and forth about the project then you look more like an employee.
By the way, in California the standard is higher - you have to meet ALL three tests (free from control, outside usual business of employer and having separate business providing the service) before you are considered an independent contractor - it is given all kinds of people heartburn!
posted by metahawk at 2:26 PM on February 19, 2022 [6 favorites]
Here is the what the IRS says.
If your friend just gives you a project and expects you to deal with it, with progress reports along the way, then you look more like an independent contractor (on the federal level, in California I know there are additional tests regarding the relationship of your work to the core products of the company)
If you are clearly in the business of being a contractor, work with other clients, pay for your basic business expenses (computer, internet, whatever) then you look more like an independent contractor.
If you are working full time for one organization, if you are working as an integral part of a team with lots of feedback flowing back and forth about the project then you look more like an employee.
By the way, in California the standard is higher - you have to meet ALL three tests (free from control, outside usual business of employer and having separate business providing the service) before you are considered an independent contractor - it is given all kinds of people heartburn!
posted by metahawk at 2:26 PM on February 19, 2022 [6 favorites]
Response by poster: Well, I guess that answers that. Employee it is
posted by rebent at 2:30 PM on February 19, 2022
posted by rebent at 2:30 PM on February 19, 2022
I don't want health insurance
There is no law that requires employers to offer health insurance. What there is is a provision of the ACA (Obamacare) that institutes a tax penalty on companies that don't offer health insurance if they have 50 or more employees. Since you're the first/only employee, it doesn't apply to this company.
posted by soundguy99 at 3:06 PM on February 19, 2022 [2 favorites]
There is no law that requires employers to offer health insurance. What there is is a provision of the ACA (Obamacare) that institutes a tax penalty on companies that don't offer health insurance if they have 50 or more employees. Since you're the first/only employee, it doesn't apply to this company.
posted by soundguy99 at 3:06 PM on February 19, 2022 [2 favorites]
One thing to keep in mind is that the article you linked was almost certainly dashed off my someone trying to make a word or post quota. It’s just words to sell advertising. It’s not useful advice.
Many governmental organizations at both the state and federal level will post guides and information about these things and they’re harder to find but better for reference.
posted by jeoc at 10:47 AM on February 20, 2022
Many governmental organizations at both the state and federal level will post guides and information about these things and they’re harder to find but better for reference.
posted by jeoc at 10:47 AM on February 20, 2022
One other clarification I haven't seen other commenters explicitly make yet:
If you are classified an an independent contractor, the concept of PTO does not apply at all, because one of the key defining aspects of being a contractor is that you manage your own work and your own hours. You can have a contract that specifies you're expected to work X hours and that you will not be available for Y days. But the person you're contracting for can't tell you that you can or cannot take time off.
If you are classified as an employee, you could be paid salaried or hourly, and the concept of PTO exists but doesn't really have anything to do with which it is.
Even though it's a tiny company, I'd strongly recommend you and your boss have a clear, written agreement about what time you'll be taking off.
And above everything else, as someone else said, your boss really needs to be consulting with a licensed pro about this--if they're not consulting with an accountant at the very least, I'd be worried about the overall future of the business itself, no matter how well the two of you work together.
posted by rhiannonstone at 5:48 PM on February 20, 2022 [3 favorites]
If you are classified an an independent contractor, the concept of PTO does not apply at all, because one of the key defining aspects of being a contractor is that you manage your own work and your own hours. You can have a contract that specifies you're expected to work X hours and that you will not be available for Y days. But the person you're contracting for can't tell you that you can or cannot take time off.
If you are classified as an employee, you could be paid salaried or hourly, and the concept of PTO exists but doesn't really have anything to do with which it is.
Even though it's a tiny company, I'd strongly recommend you and your boss have a clear, written agreement about what time you'll be taking off.
And above everything else, as someone else said, your boss really needs to be consulting with a licensed pro about this--if they're not consulting with an accountant at the very least, I'd be worried about the overall future of the business itself, no matter how well the two of you work together.
posted by rhiannonstone at 5:48 PM on February 20, 2022 [3 favorites]
This may be completely irrelevant, but another reason to go W2 employee is if you're planning on taking out any large loans anytime in the near future. Banks seem to love to see you're a W2 employee and seem to look more askance if you're self employed/1099.
posted by flamk at 12:58 AM on February 24, 2022
posted by flamk at 12:58 AM on February 24, 2022
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