During this pandemic, more companies are looking to have contract roles instead of making a commitment for a full-time role. This year in the IT ecosystems, I see many IT people becoming contractors by leaving (laid off) their full-time jobs. In my environment many people who were shy to work as a contractor became contractor.
Most people are asking on how to convert their full-time employment salary to a contractor rate.
How to convert your hourly rate?
John, is a Software Engineer. He works as a full-time employee. He makes 150K with 10 -business- days vacation, Insurance benefits, and 401K. What would be his hourly rate if he would become a contractor?
First take the 150K salary.
Then, divide salary to 2080 hours. A year has 52 weeks and a week has 40 working hours. Do the math 52 x 40 = 2,080 .
Option A: John uses 10 -business- days vacation. The vacation counts 10 x 8 = 80 hours. His hours per year drops to 2,080–80 = 2,000 .
His $150,000 annual salary makes $150,000 / 2,000 = $75 / hour.
Option B: John uses extra 10 -business- days vacation. This time vacation counts 20 x 8 = 160 hours. His hours per year drops to 2,080–160 = 1,920 .
His %150,000 annual salary makes $150,000 / 1920 = $78 / hour.
If we are good to go, then decide on;
1099 or Your Own Corporation vs W2?
W2 is mostly used by staffing agencies. In W2 employee withholds taxes for you and pays your taxes. In your own corporation and 1099 you are responsible for the tax payment.
In these two cases
- Add your health insurance about $6,000 to $8,000 for yourself. Lets say your insurance cost is $7,000.
- Add your matching 401K, amount depends on you lets say it is $6,000.
- Add 7.65 % for the tax for your self employment. On W2 there is no need to add the tax ratio. John’s tax is $ 150,000 x 7.65 % = $ 11,475.
The sum of benefits are; $7,000 + $6,000 = $13,000
The tax is $11,475
Option A, John takes 10 -business- days holiday. His hourly rate will be the following.
$24,475 / 2,000 hours = ~$12,24
Add this amount to your full-time hourly salary of $75, which makes
$75 + $12,24 = $87,24.
John’s hourly rate should be $87.24/hour on 1099.
If John works on W2, he may remove the tax from this hourly rate. His hourly tax amount is about $11,475 / 2,000 = $5.74
$87.24-$5.74 = ~$81.50 on W2.
Option B, John takes 20 -business- days holiday. His hourly rate will be the following.
$24,475 / 1,920 hours = ~$12,75
Add this amount to John’s full-time hourly salary of $78, which makes
$78 + $12,75 = $90,75.
John’s hourly rate should be $90.75/hour on 1099.
If John works on W2, he may remove the tax from this hourly rate. His hourly tax amount is about $11,475 / 1,920 = $5.97
$90,75-$5.97 = $84.78 on W2.
Downtime Adjustment
If John searches for new job between two contracts, then he may add that idle time to his hourly rates. If he searches 10% of his time for a new position then his utility ratio is %90.
He has to divide his hourly rates according to the utility ratio.
Option A:
On W2: $81.50 / 0.90 = $90.55
On 1099 : $87.24 / 0.90 = $96.93
Option B:
On W2 : $84.78 / 0.90 = $94.20
On 1099 : $90.74 / 0.90 = $100.82
Hope this helps to all!