I thought that this article might help explain things to those less
experienced in these matters. Those of you who are old pros, please excuse the
repetition (but it might make a good refresher). This is very simplified and
ignores rate caps, benefits and other deductible expenses, unemployment and
state taxes, and other complications, and it's approximate; its purpose is
just to explain the basic concept.


The 7.65% Socialist inSecurity tax (FICA/OASDI/MediCare) is paid by both
employer and employee. Self-employed pay both halves (15.3%). This is why you
need to quote a bit higher rate to get the same amount if you're an
Independent Contractor (whether incorporated or self-employed).

It so happens that 7.65% is very close to 1/13, so here's an approximation.

If you're an employee, for every $13/hr. of your rate, the employer and
employee halves of the SS tax are $1/hr. each, so your employer is paying
$14/hr., and you're really getting $12/hr. But you have to pay income tax on
the $13/hr.

If you're 1099 (self-employed), you need to quote $14/hr., because you have to
pay both halves = $2/hr., leaving you the same $12/hr. To make it work the
same way as for employers, you get to deduct the employer half of the
Self-Employment tax, or $1/hr., so again, you pay income tax on $13/hr.

If you're incorporated, it works like both of the above examples combined.
Normally you're an employee of your corp., so again, you need to quote
$14/hr., your corp. as employer will pay $1/hr. out of that leaving you a
$13/hr. wage as employee, you pay $1/hr. out of that, leaving you the same
$12/hr. And again, you pay income tax on the same $13/hr.

The next example I mention to complete the comparison, and because some people
asked about it and were confused.

If you're working through RMPCP on our 1099, we bill the same $14/hr. and you
get the same $12/hr. That's why our 15% "umbrella fee" does not compare with
the 3-5% fee charged by other umbrellas, because ours includes that $2/hr.
you'd have to pay anyway, and other umbrellas' quoted fees do not - apples vs.
oranges. Thus, our real fee is 15% - 2/14 = about 0.7%. And because we handle
the $2/hr. difference instead of you, you only have to pay income tax on the
remaining $12/hr., not $13/hr., so our fee is effectively more like 0.4%. So
that's why some people were confused and think we charge more, but actually we
charge less.


Again, this analysis skips the complications mentioned above, but it should
explain the situation clearly enough for a starting point. Now you know why
you need to quote about 8% more as an IC to get the same amount, and why this
doesn't cost the broker/client any more than they'd pay as an employer (in
fact, possibly less). That's also why when you're working through RMPCP, you
can quote about the same rate you'd normally quote as a 1099/corp. and still
get the same amount left; we effectively don't add anything to the cost.


Another way to compare this is the general rule of thumb that seems to be
floating around, that a good broker will take 20% of the bill rate if you're
1099/corp. or 30% if you're W-2. This assumes that the broker found you the
client, as usual, so it includes their commission. Again, this is only
approximate.

If the broker is taking 20% and giving you 80% on 1099 or corp-to-corp,
they're taking a 20% commission. After you pay your 15% SE tax (or your corp
and you split 15% in payroll taxes) of your 80%, that's 15% * 80% = 12%, thus
a total of 20% + 12% = 32% taken out, leaving you 68%. We're assuming no
factoring for 1099/corp as they probably don't pay you until the client pays
them. OK, maybe they're doing some invoicing and maybe some factoring, worth
about 1%, so their commission is effectively about 19%. So, if you're an IC
and the broker takes 20%, you're really getting 68% of the bill rate after SS
taxes.

If you're W-2, they're taking 20% + 10%, about 4% of which is their factoring
fee for paying you regularly and (hopefully) unconditionally as their
employee, and about 6% of which is the employer half of FICA etc., leaving
70%. Your employee half of about 6% then leaves you with 64%. That's 4% less
than the 68% above, the 4% being the factoring fee. Some of the 4% is probably
not just for factoring but to compensate the broker for the extra legal
requirements of being an employer. So as an employee, with the broker taking
30%, you're really getting 64% of the bill rate after SS taxes.

If you're working through RMPCP, there's no commission of course if you find
your client yourself, in which case you get 85% of the bill rate - essentially
the same 12/14 you'd be left with after paying the SS taxes as in the first
analysis above, whether you're W-2, 1099, or corp. If one of our other
consultants finds the client for you, your fellow consultant (not RMPCP) gets
a 10% commission (which declines to 5% after 3 months and 0% after 6 more
months), so you get 75% (with automatic raises to 85%). If we finally find and
hire a good marketing/sales partner which finds the client for you, their
commission is 10% more (20% declining to 10%), so you get 65% (with automatic
raises to 75%). So at worst case, your 65% compares very well with the 64-68%
above, and then you get automatic raises as our commission declines, while
typical brokers' commissions hang on forever.

And of course many brokers take far more than the 20%/30% of the bill rate
above. I had one once that took 35% (instead of 20%) on a 1099, and I've heard
even worse.


Robert M. Pritchett - RMP Consulting Partners LLC - member ICCA
Quality means doing it right the first time - http://rmpcp.com
Tired of hearing "W-2 only"? Work the same contract on our 1099 instead!
Email Apply at our web site above for more info. Group benefits pending.
See http://www.keen.com/rmpcp for legal/tax issues facing consultants.
We are not lawyers/accountants and are not giving legal/tax advice.