Getting started as a Contractor

Jan 31st, 2012
Getting started as a Contractor

So you’re thinking of becoming a contractor. Perhaps you are looking for the flexibility, bored in your current job, don’t want to ‘pay your dues', deal with performance evaluation or accept the micro annual increments while your contractor friends boast of their rates, vacations and easy work hours. You could be a consultant, contractor, vendor or temp which are all different names for contingent workers.

Whatever your reasons for choosing this kind of work, starting out as a contractor means that you need good information so you don't make any mistakes unknowingly. So we answer some of the most common questions about Contracting or Consulting.

OnContracting's Inside Advice to becoming a Sucessful Contractor

Get a contract job offer before you quit or get fired from your full-time job
The first and probably the scariest step is the thought of giving up your current job, the stable paycheck and benefits. The good news is that it is possible to look for contract work while still in your job, so you can interview and get an offer and evaluate the benefits and risk before you decide and make the leap. Most IT vendor staffing agencies and end clients want contractors who are available to start soon but this typically means about 2-3 weeks which is sufficient notice to your full-time employer.


Research Staffing and Consulting Companies
Research staffing agencies and consulting companies and which client companies they work for. A staffing agency directory or a consulting company directory can tell you which of the numerous staffing agencies and consulting companies are worth your time. You will do better connecting with a few recruiters and explaining to them your qualifications rather than blindly applying ot hundreds of jobs on job boards.

Leverage your network connections
You may already have contacts in your current or targeted company or industry who can give you leads to follow up, but most technical contractors use vendor agencies to find work, particularly when they are starting out.

Market your resume and build an online profile
You can start by listing your resume on a freelancer website such as OnContracting.com or job boards monster.com or dice.com or other niche technical job sites and mention you are looking for contract/temp jobs only. Soon, you will start receiving calls from staffing agencies that have contract positions with their clients. OnContracting helps you to research what companies hire contractors for what kind of work and which staffing agencies they use or just check the jobs page. If you find something you like, find a recruiter with that agency and connect or follow them to keep tabs on new jobs coming about.

What is the Process of getting a Contract Job?

Once your profile is discovered by a recruiter, you will be contacted by email or phone. Respond quickly as recruiters typically contact numerous candidates and are turned off by non-responsive candidates.

Some staffing companies might require a technical screening before they consider you for a role. Once it is determined you are a match for this position the staffing agency will submit your resume to the hiring manager.

If the hiring manager likes your resume, the staffing agency will arrange for you to interview with the client.

Most clients first do a 30-60 min phone interview to make sure that you meet the minimum qualifications.

If you 'clear' this interview, they will typically bring you in for another round of 2-3 hour in-person interviews. For technical roles, these are typically technical interviews with hands on coding questions and whiteboard problem solving.

Increasingly, companies may even require you to solve coding interview questions on online platforms. Sometimes the client manager may want to do a skype or online screen sharing interview so they can evaluate your coding and problem solving in real-time. Skype (video conferencing) is increasingly being used to make sure someone else is not doing the interview for you as some bad candidates have been found to use their friends to crack such phone/online interviews.

The client will usually make a decision immediately or within a day or two. Some clients might have a few more candidates in the pipeline so it might take some time if they want to go through their entire list of candidates. 

Contract Job Offer

The Staffing Agency will offer you the contract job on behalf of the client. They will make you an offer specifying the rate, term of the contract, and other conditions and will usually ask you to confirm acceptance within 24 hrs.

The rates should have been negotiated upfront between you and the staffing agency. Similarly the staffing agency and Client have also discussed the rate the staffing agency would charge for you including a markup for them.

Most staffing agencies have a markup fo 20-50% depending on the services they provide and the difficulty of filling the role and competition.

As a contractor you don't get to discuss the rate with the client and most staffing agencies will tell you this clearly and clients are mostly aware of this too. It gets pretty awkward for everyone if you break this rule. So if you want ot negotiate rates, first start with your staffing agency rep.

Very rarely the Client may come back after the interview and ask for a lower rate.

Some aggresive recruiting agencies will push for an immediate answer and written (email) acceptance.

If they don't have many options, they might be willing to wait a few more days although this is very rare. 

Choosing your Employee type

Usually, the first time you talk to a recruiter, some of them might ask you whether you want to work as an employee W2 (in most cases this is the only option) or 1099 (very rare these days) or Corp-Corp (sometimes also called C-C). So it would be good for you to decide upfront which option is best for you. In most cases, it is a wash for the staffing company between the W2 and Corp-Corp option, the 1099 option is a risk (employee misclassification) for them so most have stopped offering this. Here are the differences between these options

W-2 Employee of the vendor agency

1099 Independent Contractor (Sole Proprietor)

Corp-Corp Contractor (through your own Limited Liability Company or partnership)

 

Which model works best?

It depends on your own circumstances and how you have decided to operate. You may need professional advice.

W-2 Employee of the vendor agency (Low Risk, Low Reward, Not much work for you)

You are basically an employee of the vendor agency- but hired for and to work at your client. Your wages are subject to the same tax withholdings as a regular employee. Usually the client has a vendor agency that will act as the intermediary between you and them. You will receive wages from the vendor agency with the requisites taxes withheld which you get a statement of at the end of the year in a W-2 form. The vendor will probably receive 15-100% above your hourly rate to cover its expenses and profits.

Some vendor companies will provide you with medical and dental insurance options, life insurance, training reimbursements, vacation and holiday pay and even a 401(k) plans.

Pros: Easy and pain free, only worry about taxes at end of year. May include benefits

Cons: Can’t deduct expenses, no deferment of taxes

 

1099 Independent Contractor (Sole Proprietor)

A sole proprietorship is an unincorporated business that is owned by one individual. It is the simplest form of business organization to start and maintain. Its liabilities are your personal liabilities. You undertake the risks of the business for all assets owned, whether used in the business or personally owned. You include the income and expenses of the business on Schedule C of your own tax return.

Most vendor companies are wary of using the 1099 model. The IRS can review your situation after the fact and decide you were really an employee and get the vendor company for past payroll taxes and massive penalties. Therefore, to limit their exposure, most companies prefer either W-2 or Corp-to-Corp relationships these days.

If you manage to get this option with your vendor company you don't need to do anything special to get started as far as the IRS is concerned. Your state, county or city may require you to get a business license.

As far as taxes go, you should receive a 1099-MISC from your vendor company indicating the payments made to you for the calendar year. They report this amount both to you and the IRS. You report the income and deduct expenses that are directly related to the business on Schedule C. The net income from your business will flow through to your 1040, line 12 and you will pay tax on the net income at your personal marginal tax rate. The IRS will match the total income you report on your Schedule C to the total of all 1099s you receive.

NOTE: Any profit on earned income that accumulates in your business is also subject to self-employment taxes (social security, Medicare). This is true of partnerships and LLCs, too. Only corporations are not subject to this tax on accumulated earnings.

Pros: Easy to get started and discontinue when your contract ends, Losses might be used to offset other income , Small business retirement plans offer the opportunity to defer more current income than traditional IRAs, you may be eligible to take the Home Office Deduction.

Cons: Unlimited liability for the owner, all profit is subject to self-employment tax in addition to the income tax, more bookkeeping than W-2 option, pay quarterly estimated tax payments.

 

Corp-Corp contractor (working through your own Limited Liability Company or Partnership)

Corp-to-Corp means that your client (the vendor company) pays your business, which is organized as a corporation, for the services rendered by you. For this, you would have to incorporate a company. Most prefer an LLC with an S-Corp election which is a hybrid of an LLC and a Corporation. To work as a corporation sub-contractor you would typically need

  • A federal tax ID number (or Employee ID number EIN)
  • A WA State UBI number (in WA)
  • Certificate of business insurance matching clients requirements (this is expensive, but not all companies insist on this)

 

Incorporating your Business

There are several services (local accountants) that will do all the paperwork of incorporating your business for about $300-$600. There are also several web services that will walk you through the process. It isn't difficult but it is a little time consuming.

Cost of incorporating:https://www.legalzoom.com/legal-incorporation/incorporation-packages.html

Note: Once you incorporate, you and your business are two entirely different and separate legal entities. This protects you from personal responsibility for liabilities incurred by the corporation.

Record Keeping

As a corporation you will not receive a lot of the tax documents you do as an individual. You won't receive a 1099 from your agency. You have to keep track of all this. You will need to invoice your agency on a periodic basis. Make sure they are paying you in a timely manner. As a corporation, most companies will pay you 30-60 days (as opposed to 10 on W2 or 1099). You will have to get a separate checking account for your business. Your bank will not let you deposit checks to your business into your personal account. The IRS requires you to keep written records of your business. Make sure you keep receipts associate with each payment.

Payroll:

If you incorporate your business, you are an employee of the corporation and you will need to pay yourself a salary. This is true even if you are the only shareholder of the company. Therefore, you will need to set your up your corporation as an employer with the IRS, pay federal, and potentially state, payroll taxes, make timely payroll tax deposits and file quarterly and annual reports with the IRS, and possibly state employment department.

For most people this is quite a headache. Interest and penalties on late deposits and filing are quite onerous. This is one item you don't want to let slide. If you have the cash available, it's easiest to make the payroll tax deposits when you deposit your paycheck. You can avoid most of these headaches by hiring a payroll service like ADP or Paychex.

You will also need to know some of the rules about what things are subject to payroll and income tax and which are not. For example, if your company pays health insurance premiums on your behalf, those premiums are subject to income tax withholding, but not social security and Medicare withholding. In addition, this amount is included in the Officer's wages portion of the corporation's tax return, not the employee benefits line. You can deduct the amount paid for your health insurance on line 29 on your individual Form 1040

Pros: No self-employment tax, Using small business retirement plans, you can defer tax on a larger percentage of income. Double taxation of earnings is avoided as compared to regular corporations.

Cons: Most complicated option. Much more bookkeeping and tax reporting required, More difficult to organize and dissolve. Some states have a minimum tax you will have pay regardless of profitability. You must receive at least some salary from the corporation, which means the corporation is subject to payroll taxes and filing. S-Corp shareholders pay tax on undistributed profits.

If you don't make the S-Corp election you can get stuck with the 35% Personal Services Corporation (PSC) flat tax. The biggest drawback of setting up your own corporation is the extra time required to set up and maintain the records of your corporation and all the required tax filings.

WHICH IS BEST FOR YOU

Which option you decide to pursue is purely your own personal preference and should be based on your unique situation and personality. If you like a hassle free, less paperwork way or working, prefer paid vacations and need medical benefits and don’t care about saving every possible nickel in taxes, then W2 is the probably best.

If you are comfortable working with accountants or can file taxes, etc. yourself, billing and invoicing are not too cumbersome for you, and you don’t care for benefits and would rather be paid extra instead, then Corp-Corp through an S-Corp company might be good for you.

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