As more and more companies look to hire contractors instead of full time employees to get work done you may find yourself considering a contracting gig for the first time in your career. A recent study suggests that by 2020, 40 percent of America’s workforce will be contract, temporary or self-employed workers.
Many people may shy away from contracting jobs because they often do not offer paid time off or benefits. However, you can receive a much higher hourly rate on a contracting job then you would on a fulltime job. The benefits and paid time off are not FREE and your fulltime employer will pay a lower salary to cover those things.
You can successfully build benefits and paid time off into your contracting rate and feel comfortable that your contracting gig will be at least equivalent to a fulltime salary plus benefits.
Finding your hourly rate
Alice is a full stack developer who has just left a fulltime position where she was making 150K with 2 weeks vacation, medical benefits, 401K. She wants to figure out what her equivalent hourly rate would be as a contractor.
First she should take her 150K salary and divide that by the number of hours she plans to work in the year. There are 40 hours per week and 52 weeks per year so a full year with no time off would have 40×52 =2080 hours. Since Alice wants to take off 2 weeks for vacation and an additional 10 days for holidays she should reduce the yearly hours by 20 days * 8 hours/day = 160 hours. So her hours per year will be 1920.
Taking her $150,000 and dividing it by the 1920 hours gives her an hourly rate of $78/hour.
1099 or your own Corporation vs. W2
Before determining her rate Alice must know if she will be a 1099 contractor or work on the w2 of a staffing agency. The difference being that as a W2 employee the employer will withhold taxes and pay employer taxes. As a 1099 contractor or if you are working under your own corporation you will need to account for these employer taxes which will be approximately 15%.
Adjustments for Benefits
- Add $7K – Alice is single and health insurance will cost her 7K per year
- Add $11,475K (7.65%) for the extra tax Alice will pay for self employment. This is what her employer used to pay the Government (Employer Taxes). If Alice’s contracting position is with a staffing company on a W2 then this does not need to be added.
- Add for 401k matching – $6K
- Total addback for benefits and taxes for Alice equal $24,475, ($24,475/1920 hours = ~$13 dollars per hour.)
- Alice’s Rate goes up to $78/hr+$13/hr= $91/hr on 1099
- If Alice were a w2 staffing employee she can remove the additional self employment tax number so her total add on would be 13K/1920 hours = ~7/hour, so w2 staffing rate will be 78/hour + 7/hour = $85/hour w2 staffing rate
Adjust for Downtime
There may be downtime in contracting so Alice should adjust her rate to account for fluctuations in your projects. If we assume Alice will be spending about 3 months per year finding clients/off a project her utilization rate will be 80%.
Adjusting- $91/hr/0.8 = $114/hr on 1099
We have put together a calculator you can use here to calculate your personal hourly rate.
This is a great exercise to come up with a target hourly rate that you can use to start negotiations with a client. You can generally lower your rate for longer term contracts as your utilization rate will increase. Ultimately you will need to test your rate out on the market and negotiate, negotiate, negotiate.
26 thoughts on “So you want to be a contractor? Use our Calculator to Determine Your Rate!”
Interesting, accurate and well explained calculation.
Great insight to contract work. I am just beginning my own self employment, and this blog was the first step in understanding all the hidden expenses of moving from a salary to contract work. Thank you!
Katie – my name is Mike Benoit. I am considering making the jump to self employment in the consulting world. Your calculator is wonderful! Thank you. One question… I will travel for my position, I do need to confirm whether travel will be expensed, or needs to be blended into my rate. To blend, is it as simple as adding that as a line to the Benefits and Taxes calculation, expected monthly expenses * 12?
Thank you again!
Sorry I just saw this comment, glad you are enjoying the calculator. Yes if you are traveling make sure to check if they will reimburse for this or if they want you to come up with an all inclusive rate to cover this. I would figure out your costs monthly and add it that way. Best of luck to you!
I think it is mainly small businesses that will hire an independent contractor as an individual. Many small businesses do not offer health insurance or 401 k plans anyway. It is the large scale businesses that have more rules regarding offering health insurance and other benefits. Those companies may hire contractors, but it will most likely be through a contracting service company/temp agency that would offer benefits. So I think as a comparison of w2 pay vs 1099 pay it should not include health insurance or 401k calculations. Those would be on you anyway. The only difference will be on taxes….such as self-employment tax, deductions you can take as a business, Medicare/ss taxes and alike. Also, a factor are things like remote work without the commute be it your own car or transit and/or life-work balance. A w2 position will require different things than a 1099 position.
I wished I read this article 2 week ago. Anyway thanks for this crystal clear explanation.
this is very helpful thank you!
I’m nerding out on your calculator! Two things I wish it included – 1) the ability to exceed 100% capacity, such as if I’m working 44 hr (110%) or 48 hr (120%) weeks, and 2) benefit of self-employment retirement plans and the ability to tax-defer a large amount of income. These would be cool features, but thank you – the tool did what I needed it to do, even without these features!
I’ve spent quite a bit of time searching online for a useful method for calculating an hourly rate and this is BY FAR the best one I’ve found. Thank you so much.
I wish you could add two more ways of getting paid into the calculator.
2. W2 with per diem
There are various issues with this calculator for anyone else that stumbles across this (though it generally gives you a rough idea and appreciate the post):
401K Match: It assumes a dollar for dollar match on the full percentage. You might have dollar for dollar up to 3% then .50 per dollar on the last 3% (with an effective 4.5% match instead of 6%)
Health Insurance: Calculator assumes salary provides 100% of premiums paid by employer (which does exist but highly unlikely). You should enter the difference between your private insurance premiums while being self-employed vs. the monthly premium you would pay as a salary employee (i.e. Family coverage: $1200/mth private vs $700/mth employer sponsored would be $500/mth difference).
FICA / Self Employed Taxes: Salary * 7.65% is partially correct, 6.2% Social Security (caps out at $132,900  and $137,700  while the 1.45% medicare doesn’t cap out. If the salary is over $200k, additional tax of .9% applies to income over $200k.
Finally, if you are self employed with similar rates as mentioned in this post, it might make more sense to form a s-corp to further reduce your FICA taxes by moving some profit to distributions vs salary. You will likely have a few more business expenses (i.e. payroll services, higher tax filing fees) but the saved FICA taxes may be worth it.
Great article/calculator for comparisons. I’ve been a contractor for the last 15 years doing IT consulting.
Based on my situation my 1099 hourly target rate for your example is at $75 per hour.
Without going into the complexities of it for your readers, here are some other things to consider: A good way to do this calculation, and get best estimation, is to buy tax software and go through it as if you were doing a real tax form. Create 2 files, one for W-2 salary and the other as 1099. If current software is not available, I just use previous year. Go through each part of interview process. It also gives you a lot of ideas of what you can and cannot write off. I threw some numbers in here based on $150,000 salary vs 1099 contract. This just gives your reader’s other things to consider.
My tax rate: 35% bracket with spouse income. All of mine income is at this level. Yes, wife does well. :C)
1. SEP Contributions: $13,000 ($37,500 * .35) SEP deduction: up to 25% of 1099 income
2. Business Expenses/depreciation: $12,000 ($35,000 * .35) Notes: If I were W-2 hourly or salary, I would not be able to take these deductions. This is a significant amount of deductions. For example, purchased new car (-$25,000 note: I do this every 2-3 years), annual depreciation, home office, cell phone expenses, laptop, etc. I’ve been averaging $35,000 per year on things I would have to make $54,000 in salary to pay for. (This does not include reimbursable travel expenses unless I have to pay myself instead of client i.e. “all-inclusive rate”)
3. QBI: $3,500 (10,000 * .35) Qualified business income (QBI) deduction
4. Self-Employment Tax is 50% deductible Self EE: 7,458 (11,475 * .65) Self-Employment Tax is 50% deductible
5. 401K: $12,650 (includes 401k Tax savings 401k: $6,650 @ $19,000 limit + EE match)
6. Medical: $7,000 (I’m really at zero. My spouse has insurance)
This is super helpful and so clear and concrete! Thanks a million!
I feel as a contractor you can save more if you have your own corp. considering you can save lot on taxes. suppose you get$100/hr you get $200k/yr you can contribute 25% of profit then $40k and if your spouse is partner you can contribute more for your spouse as well. You can add your home mortgage as part of your office rent and car lease as office expenses. When you are on w2 you can’t save much as 35% to 40% will go on Tax for your bonus or RSU you get.. If your spouse is working you can get insurance thro’ her. Do your calculation based on your situation.
HI Sri – Good info on corp based tax savings. How did you set up your entity? Is it a C-Corp or S-Corp? Thanks.
Thanks Kate for the simple explanation, it really helped me understand contracting much better. But I have a question for you, what happens when I want to use my own corp as in C2C instead of 1099. I get lot of offers with c2c with a much higher rate, but I am not sure what to charge and risk involved in it. It will be great if you can give some example and calculator that we can use. Also, any resources or contact who can help me understand this better.
Thanks for the wonderful blog
Thank you for the comment. I will work on something about setting up a corporation.
Thank Katie. I have recently started looking for Contracting jobs and this hourly rate question always puzzled me. Thanks again for explaining it beautifully.
Great explanation. Thank you
Thanks so much for publishing this article. Question, in the example, how is the 401k matching figure of $6,000 determined. Is this the amount of matching that she will forego by not receiving an match from fulltime employment? This is not the amount that she just plans to contribute on her own, correct?
Yes this was the amount her employer was matching.
I’ve been looking for information like this and finally found it. THANK YOU! Can you point to other similar resources, books, podcasts, or websites/blogs that explore the issues contract hires should consider to make a gainful living
I like the calculator, but would add a “corporate” profit margin to account for the risk of being self-employed. Your baseline is great for matching full-time, but there is risk involved, so the hourly rate should ideally account for that and contractors shouldn’t be afraid to ask for that.
How do we calculate for difference in health care cost? AKA being a full-time employee maybe we pay $400 in monthly premiums, but when we move to a contractor at a staffing firm we think we may have to pay $600 in monthly premums?.
If the difference is 200 a month then I would put that into the calculator for the healthcare premium. Since this is the additional burden you are paying for the contract position.