The Old Joel on Software Forum: Part 3 (of 5) - Pay Rate as a Contractor v. FTE

Pay Rate as a Contractor v. FTE

I've been contacted by a recruiter and they tell me they need me to supply a pay rate (I'm giving a range) as an W2 or (that other one that slips my mind). I've never worked as a contractor and I don't know how much I should ask for to cover my own overhead.

If, for example, as an FTE my salary with benefits is 50k (nice round number) what salary should I ask for as a contractor without benefits?

Like I said, I'm giving a range and telling them more specifics can be worked out once I know more about what the job entails.

Full name:
Monday, January 12, 2004

Depends on how many work hours a year you expect. 40 hours a week times 50 weeks a year is 2000 hours. So divide by 2. $25/hr. If you work part-time, or if you expect to have a lot of unbillable hours, divide by a smaller number.

Of course, your salary isn't really $50,000/yr. It's probably $50yr plus benefits. Calculate how much you'll have to pay each month for your benefits (medical and dental mostly, and perhaps a 401k match that you're missing out on, and anything else you depend on, like flexible spending accounts).

Also, don't ask for $25, of course. Ask for $35 or $40 and expect them to talk you down. Come up with some good reasons why you deserve to paid that much. Market research is good. Tell 'em you like the company but someone else is offering you more. (it helps if this is actually true) Tell them you'd love to accept that offer but you have to talk with your wife first (strategy of the absent principle) Basic negotiating strategy. If they're pretty much already committed to hiring you, then the only way you can lose them is to ask for something outrageous or get caught in a lie.

Alyosha`
Monday, January 12, 2004

Does the W2 rate include benefits? Many contract agencies do not include any benefits even if you are W2ed.

So you need to figure out what the benefits you have now are worth that includes vacation, health insurance, 401k contributions, any other health coverage, training, sick time, pensions etc. That could could be 30 - 50 % of your Full Time pay. There are some other posts here about what to charge.

Get some quotes on medical coverage as an individual or from the agency.

As far as W2 vs 1099 the major difference is that you have to pay the employer's part of the FICA which is about 8% of gross wages. You may also have to pay other taxes depending on the local and state tax code. You will also have to pay your taxes yourself and may need more help with your taxes so add in something for an accountant. Business insurance is another issue as an independent.

If you don't know what a 1099 is I suggest you get some more data from an accountant or tax professional before you go that route. You need to know what you will have to do and the tax implications. If you go 1099 you should investigate incorporation which has its own costs.

Finally, try to find out what the going rate is for the work you will be doing. You might decide to take less but it is very annoying to find out that you are making a lot less than someone doing the same work.

john
Monday, January 12, 2004

Well, you did not say where you are, so if you are not in the US, YMMV...

W2 vs 1099 in the contract world.
W2 - you work for someone just like anyone working for a company. In most contracting gigs, you get your rate, they pay the unemployment, medicare, etc. If you want benefits, most likely you are paying for them from your part of the rate. You get zero business deductions, unless the company gives them to you.

1099 - you basically work for yourself. They pay you the rate, and you are responsible for all expenses. You also get to deduct business expenses, including education. You must also pay both sides of medicare, so it costs you an extra 7.5% for every dollar to $85k.

Most contract companies like w2, because they get all the write-offs and in general a better cut.

If the job is small, and is merely filler while you work at your real job, go 1099. You make what you make and in most cases, your real employer is paying the medicare.

If you are doing it full time, _I_ still like 1099. I don't care what someone will tell you, my personal expenses have never come close to what a company tells me my benefits cost them. Health insurance $6-8k. Life insurance $1k, liability $1k/1million in coverage. Add it all up and I was paying about $9k in benefit expenses at the absolute worst. However, I write most off as business expenses. Then I put up to 40k into my retirement, which is about 5 times what a company will let you put away. Finally, any equipment, office supplies, travel, etc. can all be written off.

If you figure that your costs will be for insurance, etc. Then add a living wage, then add 50% to 100%. This will give you a rate. The 50 to 100 percent is because a contract is as good as it lasts. While a company can lay you off, for most it is a slow process. As a contractor, you are there each day until someone tells you not to come back. W2 or 1099 it is the same way, and I can say I have never been let go because of my work, but I have see projects where after a week the funding was killed. That _risk_ is worth something and the something is cash.

Finally, even if you know the person well, remember it is business. Never make it personal. Smile coming and going. Here is a good discussion of this from the past especially about marketing yourself. You always want to be on the look out for the next job.
http://discuss.fogcreek.com/joelonsoftware/default.asp?cmd=show&ixPost=87722

I know this is a lot more than you asked for, but it is stuff you have to consider when you are going to ask for a rate. $25/hour sounds like 50k a year, but it never is.

MSHack
Monday, January 12, 2004

$40/hour sounds "high" until you actually calculate your expenses for a year. It's actually quite low for a highly experienced software developer in the United States. For example, my company's advertised rate is a few times that.

Here's a quick overview of how to calculate the rate to bill as an independent contractor. This should give you some ideas. It all assumes the United States, but I think that's safe since you mentioned "W2." (W2 means employment, only employees get W2 forms. Independent contractors get 1099s if they're individuals.)

Start with a salary you want to pay yourself. Now tack on 25% as payroll overhead. This includes all of the various taxes that are normally taken out of your paycheck by your employer; many of these have both an employer and employee component, as an independent you'll have to cover both.

Now add in any other things you'll need. For example, if you need a software and hardware budget, add that in. If you need general liability insurance and professional liability insurance, add that in. If you need travel expenses to go to conferences in your industry, add those in. If you need to pay rent on an office, add that in. And so on. These are your expenses.

Then calculate a realistic number for working hours in a year. I use 1645 hours; this is 47 weeks a year with 35 billable hours a week. (After all, you need some vacation, and you'll also probably attend a couple conferences etc.) These are your potential billable hours.

Finally, figure out a reasonable utilization factor. Most consultants use 50%; that is, they don't expect to work more than half time, so they need to bill a high enough rate to cover the rest of the year with that.

To get a reasonable hourly rate, take your expenses, divide by your potential billable hours, and multiply by your utilization factor. The number will show you why people who do consulting typically bill such "high" rates.

Note that this is if you're going to be an independent contractor or are running a corporation as I am. You'll probably have much lower expenses (for instance, no 25% payroll overhead) if you're an employee (W2) of a contracting agency, so you can ask for (and can probably expect) a much lower rate in that position.

Chris Hanson
Monday, January 12, 2004

You should ask for $50k or $50/hr.

Bella
Monday, January 12, 2004

Bottom line: contractors get an irrationally high premium. Do not blow it for yourself with your "overly logical" $50,000/2000 hours calculation. It doesn't work that way. It never did. When I was a contractor, I would bill $240,000/year. My other option was to get a FT job for about $100k-$125k.

Back in the heydey, $100 salaries were the norm, as were $100/hr contracts. I am sticking to the linear model here to give you the 50k/$50 rate.

In reality, it's not quite right, b/c benefits costs were not linear as rate increased, so in reality, your hourly rate quite might want to be HIGHER, b/c you are not realizing the massive pay differential that contractors routinely get.

You do not need to justify your rate, as all the above posters have done. It will only confuse matters, as people don't understand the premium an hourly gets. You do not want to elaborate details.

Bella
Monday, January 12, 2004

You don't want to have to justify your rate to your clients etc. The reason I posted how to calculate your rate was so you don't do something like, say, take a project at $35/hour and discover that you can't actually live on what you're billing even though it sounds like a lot of money.

Figure out your cost model, and base your rate on that. You don't have to tell people all the details, just make sure there's some rational basis for it.

Chris Hanson
Monday, January 12, 2004

"...extra 7.5% for every dollar to $85k. "

I believe it's up to 89K this year...

Mark Hoffman
Tuesday, January 13, 2004

Thanks everybody, you've been extremely helpful. I've bookmarked this thread for future reference.

Full name:
Tuesday, January 13, 2004

S-corp yourself.
W2 yourself only $30k
and get around most of the FICA payment.
leave the rest in the corp.
this limits the amount of SEP you can do, but that depends on your preference.

Bella
Wednesday, January 14, 2004

Hi there,

I'm talking to recruiters for a potential new contract - in my case they typically offer 55/hr on a W2 and when I ask if they can do corp to corp or a 1099 they say they will add 15% to the rate for the 1099.

Does this make sense? Is 15% enough to cover the extra expenses? (I guess it is as long as I have enough deductions?)

ALso, the contracts are for a year - which I assume is the reason the rates are what they are. Shorter term contracts or actual hourly work get higher rates?

thanks

JimK
Thursday, July 15, 2004

Nevrmind - I just found the anwers to Rob's similar question on this site.
thanks

JimK
Monday, July 19, 2004