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Get & Give Tax Help for Small Businesses

Figuring Equivalent Billing Rates: W-2 vs. Corp-to-Corp

I often see questions posted asking what is the equivalent corp-to-corp rate for a given hourly rate paid to an employee. I think a better question is what rate will the market bear. But be that as it may, there are several issues you need to consider if you're trying to come up with an equivalent for a starting point.

The most important point is usually what benefits do you have as an employee that you will have to make for when you switch to a corporation.

If you are transitioning from an employee of a large corporation to owning your own business you might be surprised by the employee benefits you probably take for granted. For example as an employee you probably get around 10 days off per year for holidays. You also probably get two weeks PTO for sick days and vacation. Both of those are out when you go to work for yourself. You'll only get paid for the hours you can actually bill your clients. On the other hand, you will get paid for each hour you actually work, where as if you're getting a salary you just get a lump sum no matter how much overtime you work.

You probably aren't currently getting a pension, but your company may have a 401(k) plan with employer matching. If you strike out on your own you'll be the only one making contributions.

It's also surprising the various insurance plans that cover employees. You probably get pretty good health & dental insurances policies. Maybe a life insurance policy, maybe up to $50,000 benefit and if you're really lucky your company offers long-term disability and/or long-term care policies.

Your company may also reimburse your costs for professional organizations, subscriptions, books and education.

It's amazing how quickly these benefits can add up. And you get them all tax-free.

There are other expenses you may not have as an employee. You may need to purchase computer equipment and software that you never needed before. You'll need to fork over the cash for those things too. And to further complicate things, it's only deductible to the extent it's used in your business. So if you use that new computer to play games, it's deductibility is limited.

And then there's all the time you're going to spend keeping track of your time, billing, payroll, accounting, tax preparation, etc. That's time you're not going to be spending with your kids, or mountain biking, or whatever. Even if you hire someone to do the heavy lifting, you're still going to be involved and making the decisions which takes time.

There are also a lot of deductions people like to throw out as deductible expenses that really aren't. My personal favorite is deducting your business clothes as "uniforms." Forget that one. You can only deduct uniforms that can't be worn outside work. The IRS is pretty sticky on this one. If you're a waiter and you have to wear black pants & a white shirt, it's not deductible as a uniform because those clothes can be worn outside work. Even a shirt with a logo embroidered on it is not deductible. Oh, and no deducting the dry cleaning either, unless it's while you're traveling away from home.

Another one is the home office deduction. First off, you must use your office regularly and exclusively for your business. Most people can't get past this one requirement. Also, the home office is a red flag for IRS audits and it totally complicates things when you sell your house.

Oh, and health club dues, that's a good one too. It used to be that employers offered this benefit and some still do, but it is no longer tax deductible.

It's almost impossible to come up with an exact equivalent rate for W-2 and Corp-to-Corp. But let's look that the following example:

Let's say you are single, live in California and make a salary of $120,000. In addition, you have a 401(k) plan that contribute the maximum $15,000 to and get 3% employer matching. You get health and dental plan with a $100 per month premium that's paid with pre-tax dollars. And your employer has a section 125 plan that you contribute $1000 to annually. You also get reimbursed expenses for your professional organization dues and select publications plus you usually take a class every year to keep your professional skills sharp. These expense are typically $1500 per year. And you get the usual 10 days PTO for vacation & sick days, plus the 10 federal holidays. You work in a fairly busy office so your typical work week is 45 hours. Let's use 2006 tax rates and other limits.

So given these assumptions, plus a few more about estimated costs of insurance premiums, etc., your $120,000 salary costs an employer about $136,000. Given that you actually work 2610 hours (45 hours * 48 weeks) per year, that's an hourly rate of $47 to you but $52.10 from the employer's perspective. Although most employers tend to calculate it on a standard work year of 2080 hours which would give the employer a rate of $65.38.

Now, if you charge only $47 per hour you're never going to make any money. In fact you'll be losing money especially if you need a take home salary similar to what you made as an employee. If you can drop your salary to $96,000 your company will still lose about $6,000 because of the additional expenses you have as a corporation, like the computer, taxes, and other expenses. I'm also assuming you're not making the maximum Individual 401(k) contribution just the same 3% matching you would have received as an employee.

In order to maintain your current salary of $120,000 and max out the 401(k) contributions you'd need to charge closer to $78.50/hour to have a marginally profitable S-Corp. Your take home pay the same as it would be as an employee but you could fund $44,000 to your 401(k) each year. This does allow you to put much more away for your retirement than you could as an employee.

Also, this assumes you're working pretty much all year with only about 2 weeks either on vacation or between contracts. If there's a slump in the economy, you could go months without any income.

So you can see, there's really no easy way to figure out what is an equivalent W-2 billing rate when you shift to a corporation mostly because you're trying to compare apples to oranges. I'm not sure how helpful it is even try to determine this but its a question I see alot. You're better off trying to figure out what you need to charge to make your business profitable. If you can't charge that you might be better off remaining a W-2 employee.

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Not So Fast... Leaving Out Plenty

OK I see this sort of "build-up" to a billing rate in many places and sigh because I wonder if the folks coming up with them have ever run a small business.

Let's start with the $120,000 of "salary equivalent" just for a hoot.

Employment taxes... employers share (state dependent) about $9,600-$10,800.

401K... 3% match..??? WHAT??? if I run my own business I want to match up to the 25% max allowable after making my $16,000 salary deferral. Add $30,000 for employers 401K contribution. This contribution level is also REQUIRED to provide "pension replacement" benefits.

Business liability, workers compensation, business owners policy. $2000 per year (one employee).

Advisor's fees.. if you're an S-Corp allow 2 hours per week at $250/hr so that's $26,000 for the bookkeeper, accountant, and the attorney (no kidding here folks... have you seen the tax code? Any idea how difficult an S-Corp is to run...? The IRS themselves figure an S-Corp + Individual set of annual returns takes about 300+ hours per year... go ahead... add up all those "time to complete this form" on the back of all those forms if you don't believe me).

Then add the "stuff" you need to buy... I'm a consultant so I spend about $2000-$3000 per month on supplies, software, computers, and sundries to support the business. That's $24,000 to $36,000 per year.

Training and development? I allow 10 days per year at $1000 per day (typical) so that's $10,000.

Health care. You're kidding me right? $1000 per month. $12,000 per year... EASILY.

Travel expenses... assume you can bill your client for these (?). I allow $5000 just for stuff related to business development... which while we are on the subject needs to be DEDUCTED from your annual available working days. I spend about 20 days a year on this activity.

Business development, advertising, schmoozing, whatever... $10,000 per year.

Professional memberships, journals, technical library... about $6000 per year.

Telephone and internet... are costing me $6000 a year.

Vacation? Heck if I'm my own boss I want 6 weeks off... because I have family on the other side of the planet. Another 30 days I can't bill anyone for.

Sick days... I'm 45... to be safe I allow 10 days per year.

Personal days taking care of miscellaneous crap that I can't bill anyone for... 5 days per year.

Now the important part... if you are REALLY LUCKY you can go from gig-to-gig without any "dead time" i.e. non-billable time between contracts... not me... I usually allow at least 6 weeks per year for this dead time.

PROFIT. Lets not forget this bit folks. It's your return on your risk capital and sweat equity. I want to make money on top of my expenses and salary... that's why I put up with this heartburn. I figure a 20% "BONUS" premium to base salary of $120,000 is reasonable. That's $24,000 per year.

So here is the tally:

Base: $120,000
Employment taxes $10,200
401K $30,000
Insurance $2000
Advisors $26,000
Supplies & equipment $30,000
Training $10,000
Healthcare $12,000
Travel expenses $5,000
Business development $10,000
Technical library, professional fees, journals etc $6,000
Telephone & Internet $6,000
PROFIT $24,000

TOTAL $291,200. Lets say $290,000 just to be nice.

Now how many 8-hour days do we have available to bill this amount?

Working Days in a year = 52 * 5 (what you really want to work weekend????) = 260
- vacations (30)
- sick days (10)
- training (10)
- business development (20)
- personal days (5)
- "dead time" (30)
Available Days = 260 - 30 - 10 - 10 - 20 - 5 - 30 = 155 days = 155*8 = 1240 hours.

HOURLY RATE REQUIRED = $290,000/1240 = $233/hour... to "replace" a $120,000 annual salary...

Does that compare to $78.50 quoted above? Hell no...

Now do you understand why 97% of small businesses in America go BUST within 5 years..?

I have been doing this for 10+ years. My actual billing rate is closer to $300/hour because I work in a fairly specialized field... but you get the idea... just adjust the "expenses" and "time available" to suit your circumstances.

Good Rate/Salary Calculator For These Factors

There's a free site called Skillserv that allows you to do rate -> salary and salary -> rate calculations using factors like the one's mentioned in this article. Check out this for rates and this for salary.

TIN verification

Hi Linda,

Every year we send out about fifty 1099's and every year the IRS sends notification that 4 or 5 of them have an incorrect TIN number.

Do you know of a website that I can key in a TIN number and see if it's valid for the payee's name and address?

Thank you kindly,

Tom Gillmore

SSN Verification

Yes! If the TIN is a SSN, then the SSA has a verification service available here:

You do have to register but once you do the verification service is free.

There is also TIN matching available on the IRS's e-Services website that's available 24hrs. This site is targeted to tax practitioners & I'm not sure how much is open to the general public.

The E-Services customer service folk will probably be able to give you a better idea of what TIN matching is available to the general public. That number is 866-255-0654.

Good Luck & please post a follow up if you have success with either of these.


Well I can't compete with

Well I can't compete with that, I have to give you the benefit of the doubt, you are right overall, billing can put you to the limits but if this is the case, that means that you need to change something: variable factor, choose for better packs that are right for your specific needs.
No medical life insurance

You have well break it down

You have well break it down here but there is a much better pay off with your corporation than being a moder slave (employee of other company). Ofcourse, there are a lot of risks, but success comes with taking risk.

Employer's Cost is bigger

"So given these assumptions, plus a few more about estimated costs of insurance premiums, etc., your $120,000 salary costs an employer about $136,000."

I think you're leaving out some significant portions here... FICA, unemployment insurance, etc. While FICA is a fixed percentage, the unemployment insurance can vary from state to state and even from employer to employer. Therefore, what the employer pays for you is anywhere from 7-20% higher than what you state above.

When I was with the DoJ, for project budgeting, we'd assume that on top of every salary was 33% worth of "other stuff". This might have been high since it was the government, but it's still a significant factor.

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