Q: Tax Playa, I may have an opportunity to become a contractor for my former employer. I need to figure out how much to negotiate for. Should I just use my wages and go from there?
Chris, Highlandtown MD
A: Wages are only one piece of your employee compensation (albeit the most significant one). In order to negotiate while giving yourself the requisite amount of credit, you also must include employer taxes paid, pension contributions, fringe benefits, and workplace amenities...
This is a question that comes up often as people move from wage-slavery to the sublime freedom of self-employment. Many make the mistake of simply charging their former wages and thinking they have made a lateral move. This is a big mistake.
Your employer has a certain cost to compensating you. The biggest component is wages, but there are others. Let's explore the major pieces:
This one is obvious and is the easiest part of compensation. Everyone knows what their "topline" salary is. Start here, and keep adding.
Employer Taxes Paid
Your employer has to pay two taxes in order to employ you: his half of FICA (Social Security and Medicare), and unemployment tax:
- His half of FICA. If your topline salary is less than $97,500 in 2007, simply multiply your salary minus pre-tax deductions for healthcare and commuter fringe by 7.65%. If your salary is more than that amount, subtract $97,500 from your adjusted salary, multiply by 1.45%, and add $6045 to the result.
- Federal and state unemployment tax. There are two pieces here. On the federal end, this is typically $42. On the state end, it is usually about $250. Consult your state unemployment tax rate and base for more precision.
These two taxes--employer FICA and unemployment--are costs to your employer of having you as an employee.
Most people have a 401(k) plan at work, and know how much the employer match is. The median employer match on a 401(k) is 3% up to $225,000 of salary. If you are contributing sufficiently to receive this match, factor it in accordingly. You may need to adjust this number if there is a vesting schedule to the employer match.
Do not count fringe benefits for health insurance, HSA contributions, dependent care, or commuter benefits that come as a payroll deduction--you are paying that, and it's part of the wage segment of this calculation.
Rather, count what your employer is paying on his behalf. Typically, this might include an HSA contribution, premium contributions for health insurance, paying for a public transportation token or parking, etc.
What if you don't know the value? Figure on your total health care costing about 10% of your salary, and subtract off what you are putting in through pre-tax deferral. The limit on HSA contributions is $2850 for singles, $5650 for family. The limit on public transportation tokens is $110 per month. The limit on a parking contract is $215 per month.
This is a difficult one to ascertain. This seeks to capture the value of what your employer is providing for you to work. This includes office space, a phone line, a computer, maybe a Blackberry, office supplies, use of a copier, maybe free coffee, etc. Try to put a value on this as best you can.
If you cannot find a way to do so reasonably, ballpark it as another 10% of your wages.
Totaling It Up
When you have all components--wages, employer taxes, pension contributions, fringe benefits, and workplace amenities--total it up. What you will have is the total cost of your compensation. That is how much your employer is spending to retain you as an employee.
That--not just your wages--should be your starting point in any contracting negotiation.