How to estimate as self-employed for gov't contract?

Question

I am a new start-up, I am self-employed (working as an sole proprietor, LLC), for a government agency and they are wanting to give $X for my services of software.

I need to figure out how much that that equates to. Normally, I'd just divide X by an hourly rate, but being self-employed, the taxes have me at a loss here.

From the IRS.gov site ... "Self-employed individuals generally must pay self-employment tax (SE tax) as well as income tax. SE tax is a Social Security and Medicare tax primarily for individuals who work for themselves."

How do I calculate this into the amount being offered? I would like to respond with how many hours at what rate I can do and be able to pay the taxes I am obligated to the state (Tx., no state income tax) as self-employed.

Answer 1

Taxes are a percentage of your income and that percentage varies based upon the amount of your income. There's no way anyone can tell you what you may owe without specific figures regarding your income. And even an estimate would entail you sharing at least some past figures.

It's always been my thought that if you have to calculate rates to be certain you are covering your taxes, you are charging WAY too little.

If you are factoring your income down to small percentages, you're not making enough money being self-employed. This is along similar lines of ... if you had a full time job and when you factored you monthly budget you had to figure out exactly how many gallons of gas you could afford in a week.... well, that's living on a pretty tight string. You'd need a better job.

Your rates should inherently be providing enough of a profit margin to cover taxes. Most base profit margins are around 20% overhead, but realistically some fields can easily charge 100% , 200%, 300% over your overhead. You should have an idea about which overall tax bracket you are in. That can be used as a basis but really you should be charging more than whatever that percentage is. i.e. if you are in a 23% tax bracket... you should be charging more than (overhead+23%) for your hourly rates.

Pricing is a tricky matter and no one can really help you with it. There are so many varying factors - overhead, region, skill level, experience, demand, expertise, market demand, competition - that anyone who does provide you hard numbers would merely be guessing at best.

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I would also point out that a "sole proprietorship" and an "LLC" are two different business entities. The terms are not universally interchangeable. There are tax and financial requirement differences (especially as an LLC). You may be a "Single member LLC" which operates very similar to a sole proprietorship, but that does not make you a sole proprietorship in the eyes of the law (IRS). You simply can not be both a sole proprietorship AND an LLC.

Answer 2

The short answer is if they are offering you $X, you need to factor in a lot of different taxes

Withholding - depends upon how much after expenses you can pay yourself. I generally figure 25%.

You are also responsible for both ends of Social Security (12.4%) and Medicare (2.9%) which equates to 15.3% (2018) at the very least. So you should factor in about 40% for taxes (which makes me sick to think about). Because you can expense a lot as your own business, that figure "may" come down quite a bit depending upon your circumstances.

Another way to look at $X is from the perspective of what a salaried employee would get.

In addition to taxes you will also want to factor in your overhead in running your own business, i.e. doing your own paperwork or hiring it out, making your own sales calls, handling your own contracts, etc. It takes a lot of personal time that nobody pays you for. As a developer myself, I look at what a regular salaried employee might get paid for the same job, add 25% for benefits, then add 50% on top of that. For a bid like you mentioned, something like this:

X$/hr

Benefits for salaried employee (25%) - makes it .80X$/hr (X / 1.25)

Extra taxes (~10%) - makes it .73X$/hr

Other overhead (~30%) - makes it somewhere in the neighborhood of .56X$/hr

So by that calculus your "take" will be a little better than half what a salaried employee would get being paid the same amount.

You should be able, with sites like glassdoor, to get a decent read on what the market will pay for your services. Pricing is tricky, though, but I have found government agencies tend to be pretty realistic and pay pretty well. All the companies that have lowballed me to the point of walking away have been private companies sadly. Good luck.