Don't start contracting without reading this!

May 31st, 2012
Don't start contracting without reading this!

So you’re thinking of becoming a contractor (consultant, vendor, temp, etc.)? Perhaps you are looking for the flexibility that comes with working in this way, or you are bored in your current job and looking to work on different projects to get more exposure or you don’t like having to ‘pay your dues to reach a certain level or deal with performance evaluation and ratings or accept the ‘company standard’ annual increments while your contractor friends boast of their annual rate increases and easy work hours.


Whatever your reasons for choosing this kind of work starting out as a contractor means that you need information that is really necessary so you don't make any mistakes unknowingly. So we've have answered some of the most common questions about IT contracting or Consulting if you prefer.



First step to becoming a contractor?

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.


Getting your first contract job is the next step. 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.


You can start by listing your resume on websites such as, or or other technical job sites and mention you are looking for contract/temp jobs only. Soon you should 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.


Some staffing companies might even 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 and if the hiring manager likes your resume, they will arrange for you to interview with the client. To save time most clients first do a 30-60 min phone interview to make sure that you meet at least the minimum qualifications and if you clear this interview, they will typically bring you in for another couple of in-person interviews. The client will usually make a decision immediately or within a day or two. (Some might have a few more candidates in the pipeline so it might take some time)


If you are given an offer the staffing agency would convey this to you. They will make you an offer specifying the rate, term and other conditions and usually ask you to confirm acceptance within 24 hrs although some might push for an immediate answer or if they don't have many options might be willing to wait a few more days.


VERY IMPORTANT: 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 some cases this is the only option) or 1099 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 and it would cost them about the same. There are three main options, which this guide will discuss.


·         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- 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, No real work required from you)

You are basically an employee of the vendor agency hired by 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 15-40% above your hourly rate to cover its expenses.


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) Now you are talking Mr Businessman!

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.


Many 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 company for past payroll taxes and massive penalties. Therefore, to limit their exposure, most companies prefer either W-2 or Corp-to-Corp relationships.


If you manage to get this option with your vendor company you don't need to do anything special to get started 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 (through your own Limited Liability Company or Partnership) You are the boss- the next Jeff Bezos?

Corp-to-Corp means that your client (the vendor company), a corporation, 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 (legalzoom). It isn't difficult but it is a little time consuming.

Cost of incorporating:



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.



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 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 to file taxes, etc. and billing 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.


Tags: IT contractors Seattle, IT jobs, W2, 1099, Contract jobs Seattle, Software Engineer Salaries Seattle, W2 or 1099

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