Best Billing Options for a Contract Position?

ffatTony asks: "I've finished college and found a great job, but now I'm surrounded by a number of contracting options without any real explanation of why one is better than the other. I hoped the more experienced among you could provide some insight. The three options presented to me are (1)Corp to Corp (100% payrate), (2)Independent Contractor (86% payrate), and (3) W2 Employee (62% payrate and a moderate weekly expense stipend). I understand that for the first two, I will need to pay self-employment tax. And in the first case I'll need to start a corporation (<$100, I'm assured), get an insurance policy, and workman's compensation. I'd like to hear about your experiences and any hidden fees that may be associated with each option. What do you all suggest? (Yes I'm going to talk with an accountant as well). Also can anyone suggest an online source that explains exactly what is tax deductible."

Comments

Say WHAT?

[Brento]

And in the first case I'll need to start a corporation (under $100, I'm assured).

Assured by who? If you can figure out how to start a corporation in your home state for less than $100, you need to tell me how. Most states charge more than that just for the corp license. Check out any of the incorporation web sites, and take a close look at the fees just for the state alone - before the lawyers get involved. Here in Texas, it's something like $260 if I remember right.

For what it's worth, whoever is assuring you that shouldn't be trusted for anything else they tell you, either.

#1 all the way (or #4, below)

[apilosov]

Option #1 might be a bit more complicated, but believe me, in the long run, you'll benefit from it. But read to the bottom of this. :)

The main thing is the fact that according to US Tax law, the things you can deduct as "Employee Business Expenses" are very limited. As a corporation, you are able to deduct anything that is "reasonable and necessary" (subject to some exclusions), both of those things are relatively easy to prove.

Example: You go to a hacker conference (at your own expense). You won't be able to deduct these expenses if you are just an employee.

There of course are some downsides: As employee you are covered by labor law, and generally you have a lot more rights (fair termination, timely pay, etc). Corporation doesn't have any more rights than specified in the contract, and you have to collect payments yourself, and sometimes clients are very slow in paying. Generally, the bigger the client is, the slower they pay. Big Wall Street companies sometimes take 90+ days to pay up. On other hand, they won't go bankrupt...At any case, it does good if you specify in contract terms like "2% discount if payment is within 2 weeks", sometimes that gets accounts payable moving quicker.

You will have to buy your own health insurance, and individual health insurance is quite expensive (50% more expensive than group quote at times), so do include that in your total costs for #1.

Some clients insist on liability insurance policies for your company before they can do business with you. These can run from 500 to 1500$/year, depending on what client requires.

Also, yes, its a lot more paperwork, and you MUST have an accountant to do your taxes, payroll, etc. Without it, you are a sitting duck for IRS.

There are alternative solutions, trying to combine best benefits of #1 without all the hassles: There are "fair" consulting companies that take care of all paperwork, your client's credit risk, health insurance, payroll taxes etc, while still allowing you flexibility to buy certain things tax-free and enjoy other benefits of being incorporated.

"Fair" here refers to the fact that such company charges for its services a small percentage (2-10%) of your total income, while in general, consulting companies rip you off (sometimes taking 66% of your client's fee!).

The way it works is this: Assuming you already have a client and an agreed rate, you come to such a company, and after a few sanity checks, you become an employee of this consulting company, and consulting company signs the contract with your client at an agreed rate.

Then, whenever you need to spend money on something is tax-deductible, you pay for it with company's credit card. This money will be deducted directly from your next payroll check "above the line" (i.e. before the taxes are computed).

I do that for bunch of my friends for free, and I'll certainly consider doing it for others (with minimal fee, to cover my costs), so just let me know if someone is interested in this arrangement. Alternatively, search the web, there are a few companies whose business is explicitly what I described.

Re:A few tips...

[vrmlguy]

Item (1) doesn't have to be true.

If you set up an S-corp, then it doesn't have to pay any taxes. Instead, all tax liability gets passed on to the stockholders. S-corps are usually used for businesses that will show a loss for tax purposes, allowing the owners to reduce their taxes, but they can be useful for consultants as well. One nice trick is to pass 50% of the profits to the owners (i.e., you) to cover your tax bill, the rest stays with the company to cover business expenses (computers, cell phones, etc.).

I understand that LLC's offer the same tax advantages as S-corps, but I've never owned any of them.

Why to have your own company

[Spinality]

Lots of interesting comments below. As far as option (1) is concerned: Although being in business for yourself is a Good Thing (I've had my own business since 1980), this is not a step to take for tax reasons or billing rate reasons or because of any similar short-term economic calculation. The reason to have your own business is to be an entrepreneur -- to be your own boss, and to accept all the plusses and minuses that go with that. In general, few newcomers to business should take this route; it's better to spend some time in the trenches, and learn firsthand whether a) you hate the bureaucratic bullshit and would rather take responsibility for everything, or b) you are willing to trade some bureaucracy for the security of not having to sell every billable hour, having a regular paycheck, getting health insurance, getting some coverage for periods of weak business, etc. For me, it's a no-brainer, but for most people, this independence is terrifying. And you simply won't know how you'll feel about it until you've been over the ground on both sides. IOW: It doesn't hurt to be a wage slave for a while.

Consider a parallel (actually orthogonal) argument: It's never a good idea to make a business decision or an investment decision purely for tax reasons. Why? Because, though tax issues might affect your tactics, they should not dictate your long-term strategy. Taxes should never be more than a detail. So, in the same way: Going into business for yourself is a huge decision, and it should not be done for a few apparent percentage points in billing rate. Those tradeoffs will all disappear. Instead, there's a much more fundamental choice involved that will affect you for many years, and so this choice should not be taken lightly, either way.

If you don't immediately understand what I'm saying, then you probably should spend a little more time in the trenches getting a sense for how business works. Eventually, you'll see a stark contrast between those who do-for-others and those who do-for-themselves, with advantages on both sides.

Here's another way to view the contrast. Picture an experienced chef who works for a Marriott hotel, and contrast that career with that of a chef who owns a bistro in a small town. They both do similar technical things; but their lives are very different. They each face real risks -- each job can be lost due to bad sales, because of bad employees, each can get sick, etc. -- but the chef/owner accepts a much broader range of challenges and makes a longer personal investment.

I hope these comments are useful. Obviously, there's a certain fungibility in contemporary consulting contracts that makes an independent tech contractor less like a chef-owner. Yet there's no intrinsic reason this contracting/employment situation must persist. After five years as a quasi-independent, you might find that you've either a) falsely convinced yourself that you're really running a small business, without a good enough understanding of the business side to make it on your own for the long term; or you've b) cut yourself out of a legit corporate job, if you're really a PHB at heart; those years as a corporate gofer are important training if you want to play those games. And there's nothing intrinsically wrong with aspiring to be a PHB. We joke about it, but most of us wind up seeking that path.

HTH