Start with annual hours you will really bill
Salary pays for holidays, vacation, sick days and slow weeks. A contract usually pays only for hours worked. If you expect to take weeks off or have gaps between contracts, the annual income is the rate times the hours you will actually bill, not times a full year.
Be honest about gaps. A rate that looks 50 percent higher can be a pay cut if you miss two months a year.
Add the costs an employer used to carry
As an employee, your employer pays part of Social Security and Medicare tax. As a contractor, you pay both halves through self-employment tax. You also cover health insurance, retirement savings with no match, equipment, software, liability insurance and the time you spend on invoices and taxes.
Put a dollar figure beside each. The rate has to cover them, plus the salary you wanted.
A simple way to compare
Take the salary and add the value of benefits you would give up: the employer share of health insurance, retirement match, paid time off and bonus. Add the extra tax you would pay as a contractor. Divide by the hours you expect to bill. The result is the hourly rate that matches the salary.
If the offer is below that rate, you are taking a pay cut with more risk. If it is well above, the contract may be fair, but check the hours and the length.
A rough illustration
Take a $90,000 salary. Add $12,000 for the employer share of health insurance, $3,600 for a retirement match and the value of fifteen paid days off. Then add the extra payroll tax a contractor pays on both halves. Suppose the total comes to around $115,000 of equivalent value. If you expect to bill 1,800 hours, the matching rate is about $64 an hour before your business costs.
Your own figures will differ, and these are examples only. The point is the method: convert the salary and benefits to one annual number, then divide by billable hours.
Taxes work differently
Contractors usually make estimated tax payments during the year instead of having tax withheld. Set aside part of each payment as it arrives, so the bill in April is not a surprise. A percentage that fits your situation is for your CPA to help you choose.
Where you live and work matters, since state rules differ. Some states apply their own tests for whether a worker is a contractor or an employee, and a wrong label has consequences for both sides.
Questions to ask before you sign
Ask for the length of the contract, the minimum hours, the notice for termination, who owns your work, whether you can take other clients and when payments arrive. Net 30 or Net 60 payment terms change your cash flow.
A calculator that sets the two side by side, with your own assumptions, saves the arithmetic. The Contractor vs W-2 Simulator on this site does that, and an accountant can review the result.
Common questions
Is 1099 income always higher?
The rate is often higher, but after taxes, benefits and gaps the take-home can be lower. Compare on the same basis.
Can I deduct business costs as a contractor?
Often, yes, for ordinary and necessary costs. Your CPA can say which apply.
Does the simulator replace a tax professional?
No. It is a planning tool for comparison. Your CPA can confirm the figures.
This guide is general information, not tax, legal or accounting advice. Rules, fees and due dates change; check with the IRS, the NJ Division of Taxation or a licensed professional for your situation.