By Joseph Reinke, CFA
At FitBUX, we’ve been getting a lot of questions from students and new grads about being a 1099 employee vs a W-2 employee because they are trying to figure out ways to make more money (another name for 1099 employee is an independent contractor. 1099 simply refers to the form filed with the IRS for taxes). The primary question they ask us is how to negotiate with a would be employer for more money should they choose the independent contractor route. In this article we discuss what an independent contractor is, a simple framework for figuring out how much money to ask for, and other items you should consider when making your choice.
What Is An Independent Contractor?
When you are a W-2 employee you are considered an employee of a company in the eyes of the IRS and Federal/State governments. Therefore, your employer’s expenses to employ you far exceed the wages they pay you.
For example, if you make $70,000 per year your employer must pay additional items such as social security tax, medicare tax, benefits, etc…
When you are an independent contractor, you are considered self-employed by the IRS and government. In short, you are responsible for providing your own benefits and paying your taxes. Therefore, you must consider this when figuring out which is more beneficial, being an independent contractor or W-2.
A Simple Framework For Negotiation
A simple rule of thumb would be to ask for a minimum of 15.3% more than if you were a W-2 employee. For example, if you would make $70,000 as a W-2 employee then as a 1099 employee ask for a minimum of $80,170 ($70,000 x 1.153). This is the minimum because you are responsible for paying social security taxes and medicare taxes.
Asking for 15.3% more would also give you the opportunity to do more than just “break-even”. This is due to other write offs and benefits that are open to you as an independent contractor which I discuss in the next section.
If you want to negotiate more then you have to look at it from the employer stand point. Taxes, benefits, and fees cost employers between 25% and 35% of an employee’s wages (Source: I used to value workforces and this is the general range from various paid databases). This means if you are making $70,000 per year, it actually cost your employer between $87,500 and $94,500 per year to employee you.
With that knowledge in mind you would be able to position yourself better. For example, you could ask for $85,000 annually and position it to the employer as an opportunity for them to save between $2,500 and $9,500 per year. It may not seem like a lot but imagine if the employer had just 10 employees. That would be between $25,000 and $95,000 extra in their pocket.
Taking it One Step Further
For those that want to negotiate further with your employer, you may be able to get a little more by factoring in time in a half.
For example (and for illustration purposes only), many states require employers to pay you more for each hour you work over 40 hours in a week. If you make $40 per hour as a W-2 employee then, for example, for any hour worked above that you would make $60 per hour (this is why many companies don’t let you work overtime).
Many independent contractors we speak with work between 50 and 60 hours a week. Therefore, you can figure out how much more this would be and add it to your hourly wage or have your contract specifically say you get an extra amount for each hour you work over 40 hours a week.
Getting More Granular
For those that want to go deeper into comparing how much more money you’d have as an independent contractor vs. a W-2 employee, you would need to build a budget and compare after-tax take home pay and which one gives you the ability to accumulate more in assets or pay down debt…notice I didn’t say buy a fancier car.
Below are three additional items to consider (We highly encourage consult a tax accountant if you are thinking of pursuing this route…):
1. Being an independent contractor opens up more choices for retirement vehicles such as SEP IRAs and Solo 401ks. These each have greater contribution limits than traditional retirement vehicles and allow you to accumulate more assets and reduce your annual income taxes.
2. Right offs. Being an independent contractor opens the door to being able to right off various expenses such as car expenses, con-ed, etc. You can be really creative with this one.
3. There are other small items you can take advantage such as if you work a certain mileage from you home. Some tax laws state that if you work x amount of miles from your home you can receive tax breaks.
One Drawback Of Being An Independent Contractor
One thing all self-employed individuals complain about is getting a loan. This isn’t necessarily a negative, you just have to be aware of it. Although you make more money, often times the amount reflected on your tax return is much less. Because of this, it will be harder for you to qualify to do things such as refinance your student loans, get a car loan, or get a mortgage.