Contract vs employee?

July 18, 2007 2:07 PM

Out of the blue, I got a job offer -- a very compelling job offer. The only thing that sets off any alarms for me is the fact that I would be a 1099 contractor instead of a full time employee. Help me understand what the difference is.
posted by boo_radley to work & money (24 comments total)

Taxes suck hard for 1099. You need to set aside (on your own) about 30-35% of your gross pay in a savings account if you want to survive April 15th.
posted by Riemann at 2:09 PM on July 18, 2007

The only technical difference (that I'm aware of) is the tax status. Being a 1099 contractor rather than a W-2 employee means that the company will pay you in big checks without taxes withheld. As a result, you will have to pay taxes yourself, which results in 2 significant changes you need to know about up front: 1) you will have to pay "quarterly estimated" taxes, you may NOT wait until April 15 to send in the entire amount*, and 2) you will have to pay the self-employment tax of approximately 15% of AGI in addition to the relevant income tax.

Beyond that, there are both benefits and drawbacks to being a 1099. A big benefit is that you get to deduct "business expenses" pursuant to your self-employment, and this can cover a wide range of stuff like computers, office furniture, and mileage/depreciation on your car, depending on what's relevant to your job. In addition, because you are an independent contractor, you generally have more freedom in terms of setting your own schedule, or it's at least more reasonable to ASK for such leeway.

On the downside, 1099s are typically not given benefits such as IRA matching (and a 401(k) is right out), healthcare, and stuff like that. You must establish these things up front! You don't want to get screwed into uninsured-dom by mistake. Also, while your schedule may technically be more "flexible," you will almost certainly be exempt from any protections such as limits on hours or payment of overtime, and you will have no paid vacation. Also, unless you really get going with the business expenses, generally the self-employment tax is quite a burden.

As a ballpark figure, you should be looking for at least a 25% raise over your current salary just to break even, considering all of these things. And possibly substantially more, depending on how much health insurance you need.



* at least, not after the first year.
posted by rkent at 2:16 PM on July 18, 2007

In addition to the tax issues, there is also the fact that you would be responsible for your own worker's comp, and were your contract canceled, you would not be eligible for unemployment insurance benefits.

Bear in mind, though, that just because a company CALLS you an independent contractor, it doesn't necessarily mean that you ARE one.

You can read more about it here.
posted by dersins at 2:20 PM on July 18, 2007

To be a little more specific, as a contractor you are responsible for all of the regular employment taxes. So normally, your employer pays half of your FICA and Medicare taxes, but as a contractor you would pay all of these. You can look up the exact rates on the IRS' website, but I think you owe between 14-15% for FICA and Medicare taxes, and then you have to withhold your own income taxes as well.

Besides just withholding your own taxes you also have to make sure you file estimated taxes periodically with the IRS or you will get penalized when you file.

Finally, when you are a 1099 contractor you will not get any benefits, like health insurance, vacation days, etc.

I think the difference in pay would need to be significantly higher at the new job for you to seriously consider it. Usually I would guess you would need to make at least 35-40% more to come out equal after the higher taxes and no benefits.

-on preview, I agree with most of what rkent says (in fact, I wasn't thinking about the upsides), but I think 25% is too low.
posted by bove at 2:20 PM on July 18, 2007

There are many differences, both in how you are legally seen by the employer and in how you may be perceived by other employees. This is an important decision as what you decide has bearing on everything from health insurance to tax.

I would suggest doing a quick google search, or checking out the IRS publications.

A good place to start is Thinkamajob's well-written sheet that talks about the differences and that is available here.

Congrats and good luck in whatever you decide.
posted by richardhay at 2:20 PM on July 18, 2007

Taxes are the biggest thing -- keep in mind you need to pay into Social Security for a certain number of quarters to qualify for payments.

It can also mean that you are not entitled to certain benefits that an employer pays for (like unemployment and worker's compensation). It may or may not have consequences for your protections under other laws, most notably civil rights laws that protect employees (these laws are generally concerned with whether you actually ARE or ARE NOT an independent contractor, not what the employer tries to classify you as).
posted by dpx.mfx at 2:22 PM on July 18, 2007

Before you decide that the offer is "compelling", it sounds like you'd be well advised to figure out how much of that offer would have to be paid out by you as taxes.

The residue might not be all that compelling.
posted by Steven C. Den Beste at 2:26 PM on July 18, 2007 [1 favorite]

I work for a real estate company as an employee. Our agents are independent contractors. The one thing I've heard about 1099 status is that you must have sufficient self-discipline to handle the responsibility.
posted by Carol Anne at 2:38 PM on July 18, 2007

A friend of mine has been doing that for years now. His first year was quite an awakening tax-wise, so he relates. He only half-jokes that he has to buy new toys (ie computers, new truck, etc) every year, putting himself horrifically in credit debt just to write them off so he doesnt go into the poor house at the end of tax season.

But he does make some serious money, only works about 7-8 months out of the year, and of course always has new toys. Not sure all the stress is worth it.
posted by elendil71 at 2:41 PM on July 18, 2007

Also, make sure that the employer is not trying to avoid paying you benefits by calling you a contractor. There are IRS requirements about how your job is structured in order to be considered a contractor, if they are not complying with the regs, you could end up in a bit of a mess...
posted by HuronBob at 2:47 PM on July 18, 2007

He only half-jokes that he has to buy new toys (ie computers, new truck, etc) every year...

Except some things you have to capitalize and depreciate, according to the regs, rather than replacing them every year. Fortunately few 1099s get audited, but there's a lot of misimpressions out there about how much you owe and what you can deduct from it; anyone who's consulting for more than a few months should spend the time and money to run all the clever schemes by a good accountant before putting them into effect.
posted by rkent at 2:52 PM on July 18, 2007

Also, it is usually easier to terminate an independent contractor (1099) than it is to lay off an employee. (YMMV) So you need to assume that if there any cut backs, you may be very vulnerable.

Also the IRS and the state are both on the alert for contractors who are really employees. There is supposed to be a qualitative difference in the nature of the work (not just taxes and benefits) Some companies to comply by having rules about the terms for independents - eg: if full time then not for more than x months. Here is an example of some of the criteria used to determine which one you are. Of course, not all companies pay attention and from what i've read (IANAL) it seems like the company would be in more trouble than you if they classify you wrong.

In any case, you should be prepared for this to be shorter term relationship than a traditional employee.
posted by metahawk at 3:04 PM on July 18, 2007

same here, my first year was a hell of a surprise. luckily I had a substantial amount of capital to balance the tax; schedule c is your friend.
posted by dorian at 3:05 PM on July 18, 2007

Ditto Metahawk. I've been a freelancer (ie, 1099s not W2s) for almost all of my working life, and I've had at least one big client that required me to submit extensive paperwork that proves I'm not a regular employee being treated as a contractor because they're concerned about the IRS flagging them for exactly this kind of abuse.

If the job you're being hired for involves you showing up at their office every day; or if it involves all or nearly all of your income coming from them, then they're trying to pull a fast one on the IRS and screw you out of benefits.
posted by adamrice at 3:26 PM on July 18, 2007

Your employer contributes an additional 7.5% of your pay for FICA(Social Security). If you're self-employed, you'll pay that. Your employer probably gives you sick & vacation time. Your employer may contribute to pension or 401k, and health insurance. Some of these things will become tax-deductible if you pay them yourself, but tax deductions are only as good as your marginal tax rate. Add up the costs of replacing benefits to get a true comparison.
posted by theora55 at 4:52 PM on July 18, 2007

You'll have to buy your own computer (unless they don't obey the law) and maybe won't be allowed to be at their office.
posted by k8t at 5:14 PM on July 18, 2007

If you can at all afford it, open up an SEP-IRA, which will decrease your tax liability (contributions aren't taxed) and make up for the retirement package you aren't getting by being a contractor rather than an employee.
posted by azure_swing at 5:14 PM on July 18, 2007

Also consider that as a result of the MS Permatemp suit, contractors can only work for a client for a year, after which they must take a 100-day hiatus from that employer.
posted by Clave at 5:22 PM on July 18, 2007

Clave, that's internal MS policy, not law. Contractors all over the States work for entities for much longer than that -- especially for the DoD and other federal agencies.
posted by kdar at 6:54 PM on July 18, 2007

Before you decide that the offer is "compelling", it sounds like you'd be well advised to figure out how much of that offer would have to be paid out by you as taxes.

The residue might not be all that compelling.

Isn't that true of any job? You're always offered the pre-tax sum; regardless of who pays the tax, your net income is the same.

An important distinction, however, is vacation/sick/personal time. Assuming you take 2 weeks vacation and another week in personal/sick time, that's about 6% of your salary.
posted by mkultra at 7:32 PM on July 18, 2007

regardless of who pays the tax, your net income is the same

no, the 6.5% employer FICA match is invisible to the employee.

2nding the PTO diff, too. I think 20/days per year is average, plus the ~10 legal holidays you won't get paid for . . . that's well over 10% of the total work year (52 x 5).
posted by Heywood Mogroot at 8:47 PM on July 18, 2007

So, let's say that everybody at the company is full-time, 40hrs 1099 status. Including the president of the company. I honestly don't know what to make of this.
posted by boo_radley at 8:32 AM on July 19, 2007

What kind of company is this? How long has it been around? If they're not putting anyone on the payroll, that's a red flag to me- makes me wonder what other corners they're cutting.
posted by mkultra at 9:41 AM on July 19, 2007

Yeah, I wound up getting a generally skeevy sense from the outfit for just this reason alone. Everything else seems to be alright, but the president is a contractor? That dog don't hunt.
posted by boo_radley at 7:16 PM on July 30, 2007