Retirement/Tax Benefits of Independent Contractor

[inquisitive]

Am considering my options for next year and have the chance to obtain an employee position or to be an independent contractor. If all other things were equal (benefits, job security, flexibility, etc), which they obviously are not, it seems like IC has some clear tax/retirement benefits, these being ability to contribute far more than $17,500 to a retirement plan and ability to defer paying taxes until the end of the calendar year (or do taxes still have to be paid throughout the year?)

For those of you who have done it, should these benefits really push me toward an IC position? As far as SE taxes go, it won't make much of a difference because the higher salary as an IC will be offset by higher taxes.

 

[samclem]

it seems like IC has some clear tax/retirement benefits, these being ability to contribute far more than $17,500 to a retirement plan and ability to defer paying taxes until the end of the calendar year (or do taxes still have to be paid throughout the year?)

For those of you who have done it, should these benefits really push me toward an IC position? As far as SE taxes go, it won't make much of a difference because the higher salary as an IC will be offset by higher taxes.

Taxes on your earned income have to be paid as estimated taxes throughout the year.
The ability to have a Solo 401K as an IC is a significant benefit, but do take a look at the downstream consequences. You are only deferring taxes, not eliminating them, so it's even possible that you'd pay a >higher< rate later (when SS starts coming in, etc). If you are facing a "tax torpedo" like this, deferring only the amount allowed by a good 401K plan (plus your regular IRA contributions) might be plenty. Look at all the benefits that would be offered to you as an employee before deciding that going IC is better.
Also, think through the health insurance issue. If you are on your own as an IC, do you qualify for an ACA subsidy? Will the actual care you can receive (availability of doctors, etc) be better under your employer's plan?

Using IC's is a way companies can rapidly tailor their workforce to meet demands> That means the ICs are the first to be cut if business falls off.

 

[target2019]

On a 1099, getting client payment is always fun (not). They may ask you to carry liability insurance too.
If you do this don't wait to pay taxes. Open up last year's turbo tax or whatever, put in the SE income and go with the quarterly payments that keep you out of penalty box.
State taxes too!

 

[Sunset]

You will also be missing out on employer matching of 401K contributions, and health plans.
Your higher salary had better be quite a bit more than the extra taxes or its not worth it. You will need to get 30% more than employee salary.
You are taking other risks too, for example they could decide they are unhappy with your work, well as an employee they still have to pay you for it, as a IC they don't pay. If they went bankrupt, you are last in line after employees so you would get nothing. They might want billing once per month, so you have to budget well.
You will be spending time billing them, and that is on your time.
Do you have to supply your own equipment ?

 

[inquisitive]

Taxes on your earned income have to be paid as estimated taxes throughout the year.
The ability to have a Solo 401K as an IC is a significant benefit, but do take a look at the downstream consequences. You are only deferring taxes, not eliminating them, so it's even possible that you'd pay a >higher< rate later (when SS starts coming in, etc). If you are facing a "tax torpedo" like this, deferring only the amount allowed by a good 401K plan (plus your regular IRA contributions) might be plenty. Look at all the benefits that would be offered to you as an employee before deciding that going IC is better.
Also, think through the health insurance issue. If you are on your own as an IC, do you qualify for an ACA subsidy? Will the actual care you can receive (availability of doctors, etc) be better under your employer's plan?

Using IC's is a way companies can rapidly tailor their workforce to meet demands> That means the ICs are the first to be cut if business falls off.

While I would still pay taxes at withdrawal the benefit of the retirement plans is that the amount accumulates tax-free, right? So I would still get a tax benefit. Is there an equivalent Roth for the self-employed? The question is how big of a benefit this is. It just seems that if I can put in $50,000 instead of $17,500 it would make a big difference in a few decades.

Sunset, that's a good point with the matching contributions. I will calculate how much I am getting currently.

I will not have to do billing nor supply equipment. I have not negotiated on my rate but I do not think that the amount I will be paid will be any more than a usual employee rate plus what the employers would pay in taxes (which I would have to pay instead), as I am doing similar work to what an employee would do, the draw for me was flexibility in terms of the number of hours I would work and when I would work them, and as someone else pointed out, if they had to downstaff I would go before employees.

Am looking into health insurance plans now and this may sway me. Although I am healthy I think it's important to have a good plan and I have not found any reasonable independent plans. I might try to find a part-time employed position with benefits and then work as an IC in addition.

 

[aja8888]

Here is an IRS write up on solo 401k plans:

One-Participant 401(k) Plans

 

[Sunset]

I can tell you that contractors make quite a bit more than employees in cash, plus the contracting company adds 25% or more to the bill, I've see 80% added.
So do not let them pay you employee rate + 7.5% + 2% for extra taxes (actually taxes part is a combination of stuff).
I would NEVER take a contract job at less than employee wage + 30% (and that is being nice and cheap to an employer).
Do not forget the benefit not yet mentioned, as an employee when laid off you get unemployment worth depending upon State about 10K for the 6 months. As a contractor you get Zero.
So your rate has to include a minimum of extra $6, so that if you last a year after taxes that extra $6 is the 10K you won't get as contractor.
I have swapped back and forth as contractor/employee so I apologize if I come across too strongly, but I have seen many a person cheated.
Be sure to specify in the contract your hourly rate, never weekly/monthly, otherwise you will be working overtime for free.

 

[Sunset]

Here is an IRS write up on solo 401k plans:

One-Participant 401(k) Plans

This is re-assuring to read, as it confirms info on the vanguard site.
The vanguard site I quoted has a calculator that takes care of the complex calculations involved. You only need to know your net income (gross - expenses).

 

[aja8888]

I work as a contractor now (part time) and have been for a couple years. I bill at twice what my "employed" rate was and I got them to cover the liability/workers comp insurance for me. I bill travel expenses at full cost + 15% when a project is out of town.

 

[aja8888]

This is re-assuring to read, as it confirms info on the vanguard site.
The vanguard site I quoted has a calculator that takes care of the complex calculations involved. You only need to know your net income (gross - expenses).

I have my solo 401K with vanguard.

 

[samclem]

I have swapped back and forth as contractor/employee so I apologize if I come across too strongly, but I have seen many a person cheated.

Did the people get cheated (e.g. promised something that wasn't delivered), or did they just agree to a deal that turned out to be less than they could have gotten? That's not the same as getting cheated.
I agree that a lot of people see the hourly rate that contractors make and get starry eyed, undervaluing the benefits they get as employees.

 

[inquisitive]

Maybe I am not thinking about this correctly or there are differences between my field and others. I have skills that are in high demand, are not developable within a few years time, and many companies are short-staffed not only in my area but nationwide. I know people who are working as part-time employees without benefits, setting their own hours/schedule, paid on a W2, who have access to a 401k, and people who are working as independent contractors, also setting their own hours, presumably paid on a 1099, not eligible for a 401k but who can set up their own, and are doing the exact same work, and the situation has been like this for years. Given that companies are short-staffed, I think I would be able to negotiate my hourly rate either as a part-time employee or an independent contractor, so the differences seem very slight. I do think there is an expectation/requirement of an ongoing work relationship for employees, and a certain number of hours being worked per month, but other than this I do not see a difference.

If in your positions you are doing the exact same work, and could be doing it part-time as an employee, what justifies the higher salary as an IC, if unemployment is not really an issue? Or is it just the idea of unemployment, regardless of the actual situation, that justifies a higher rate?

I have noticed that in one of my workplaces ppl sort of seem to look down on the ICs, maybe because they do not seem as fully invested and are making a lot more than the company employees. I did hear that they are paid overtime. So actually maybe I am starting to see what everyone here is alluding to... But there's still nothing to prevent me from negotiating in advance for overtime as a part-time employee, right?

It almost seems as if I apply for a new position as an IC, the expectation is just that I am going to get a much higher rate. Maybe the IC just have the better negotiating, which explains the rate difference, and are able to negotiate based on the overall differences, which don't always apply in the specific cases.

 

[Sunset]

Did the people get cheated (e.g. promised something that wasn't delivered), or did they just agree to a deal that turned out to be less than they could have gotten? That's not the same as getting cheated.....

I agree.
I used the term cheated as opposed to a bad deal, because these people did not make the agreement knowing all the substantial facts (hours, normal pay).
I have nothing against a person making a bad deal. In fact people could think I made one once simply because I wanted to work at a location for 6 months, so I took an extremely low rate to get the work.

 

[samclem]

If in your positions you are doing the exact same work, and could be doing it part-time as an employee, what justifies the higher salary as an IC, if unemployment is not really an issue? Or is it just the idea of unemployment, regardless of the actual situation, that justifies a higher rate?

If a part-time employee is offered any benefits or compensation that's not in the hourly rate (some matching 401K, medical benefits, paid vacation, tools/uniforms, overtime pay, even an expectation of more hours when the company could otherwise have sent you home), then the company is obviously paying more for each hour of work than the stated hourly rate for that part-time employee. In these cases, the IC (who isn't getting any of these benefits) can and should negotiate for a higher hourly rate than a PT employee would get--because the company is actually compensating the PT employee more than what is stated in the hourly dollar compensation. That just evens things out. But there's more . . .

The company also saves quite a bit by having an IC come in just for the specific time that is needed, and the flexibility to let them go at the drop of a hat. The ICs also cost the company less in overhead (time lost as they attend the mandated sensitivity training, fire safety, Blue-eyed People Sisterhood Luncheon, costs for the required HR people to manage their records and reviews, etc). Companies normally expect to pay for that flexibility and reduced overhead in the higher hourly rate they pay to ICs, and an IC should leverage that to the full advantage, or he is just giving away his time and skills at less than their true value.

 

[Sunset]

I have noticed that in one of my workplaces ppl sort of seem to look down on the ICs, maybe because they do not seem as fully invested and are making a lot more than the company employees. I did hear that they are paid overtime. ....

Wow, I loved being looked down upon by employees, at one place when not retired, I worked 70 hours weeks every week. So did the employees.
Difference was I was paid for 70 hours, an employee showed me his paycheck and he got paid 40 hrs and unpaid 30 hrs.

Employees that accept unpaid work, do not value themselves or their life, as all of us have a rough avg 80 yrs which is 700800 hrs.

I think employees have some false beliefs, like:
the company values us,
I will get a promotion due to all this extra free work I'm doing.
Come layoffs all the employees are safe.

Think of this, assuming you work at a public company (has shareholders), since everyone works hard and is responsible, what justifies the CEO making 450x the avg worker pay. The CEO is an employee.
Difference is the CEO like IC just say they won't work for regular employee pay, so pay more, and the company does.

 

[Sunset]

I have skills that are in high demand, are not developable within a few years time, and many companies are short-staffed not only in my area but nationwide.

I had to reply to this part separately, because if true, then you need to double your hourly rate and become an IC.

A simple test for you would be apply to similar jobs in some other place as an IC at double your rate, if you get interviews, then you know its true.

Certainly you should talk to some of these "looked down upon" IC's at your company to ask how did they apply, what job boards to look at, etc.

 

[inquisitive]

This really clarifies things. Sunset, when I read your post I felt an impetus that I should be an IC. I looked more into it today and have a few things to figure out (health insurance, etc), but I think that I will take the plunge. Thanks for all the info everyone!

 

[Options]

Wow, I loved being looked down upon by employees, at one place when not retired, I worked 70 hours weeks every week. So did the employees.
Difference was I was paid for 70 hours, an employee showed me his paycheck and he got paid 40 hrs and unpaid 30 hrs.

Employees that accept unpaid work, do not value themselves or their life, as all of us have a rough avg 80 yrs which is 700800 hrs.

I think employees have some false beliefs, like:
the company values us,
I will get a promotion due to all this extra free work I'm doing.
Come layoffs all the employees are safe.

Think of this, assuming you work at a public company (has shareholders), since everyone works hard and is responsible, what justifies the CEO making 450x the avg worker pay. The CEO is an employee.
Difference is the CEO like IC just say they won't work for regular employee pay, so pay more, and the company does.

+1
Spot on, particular the part about employee false beliefs.

 

[Sunset]

There is one caution about being an IC, we have not mentioned.
In many places you will find (ex IT) , that they will keep an IC a max of 1.5 yrs.
Now there are always exceptions, but it is very common.
So you have to be prepared mentally to be let go, and find some other place to work. If you leave on good grounds (meaning the people like you) then you can get hired back after 6 months.
In IT they will always say the client is looking to covert an IC to employee, but it rarely happens and I think the head-hunters just say that to give the illusion of stability to the IC (and an excuse for lower pay).
The periods of unemployment are of course another reason for higher pay for IC's vs employees.

 

[pixelville]

Remember also to take holidays, vacation, paid-time off into consideration in determining your IC rate. In addition to benefits (SE tax, 401k match, bonus, health, dental insurance, stock, employee discounts), also consider cost of equipment (laptop, software, cell phone, office space, etc). And time between projects that will not be paid or for times when you are only needed 30 hours in the week, etc. No raises or promotions based on performance.

A lot of time you spend as an IC is not billable - contract/SOW, administrative stuff, training, time tracking, invoices, time spent booking business travel, travel time, doing business trip expense reports, etc, etc. Say the department you are working with has a half-day team building offsite/picnic. Employees will be paid for that time but not IC.

I have found that getting the equivalent employee compensation takes a lot more work as an IC. And IC work may appear to offer a lot of flexibility, but likely is not the case.
Of course it will depend on your field of work.

More effort on your part as an IC estimating and paying regular taxes, local business license stuff, more complex tax returns, business expense/mileage tracking.

IC is good for someone who wants to ease into part-time work or retirement, but I would not recommend it for someone full-time or in the early or mid part of their career.

 

[dallas27]

It's worth forming an llc if you want to shift some income to a spouse. Also, it doubles your pretax contributions from 52k a year to 104k. I live the fact that i can avoid paying fica tax on most of it.


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