Contractor Pitfalls and Pluses
By Karen Tobeck
These days, a lot more people seem to be choosing to become contractors and while the thought of leaving conventional employment and worrying about new tax implications is intimidating, there are a number of potential attractions in this work arrangement:
- A higher hourly pay rate
- More flexibility of working hours
- Claiming expenses against income
- Greater variety of work
Of course, for some, contracting is forced on them by changes in their personal or employment situation; the stress of this can make the administration requirements seem even more daunting. Whichever way you look at it, you need to know what you are getting into, how best to avoid the pitfalls and how readily you can access the benefits.
Most contractors would use one of four legal vehicles to run their new business: sole trader, partnership, limited liability company or a trust. There are many reasons why you would choose one particular structure over another and it is important that you get advice on which one is best for you. Your advisor can help you with this. Whichever one you choose you will need to raise invoices for your work, possibly charge GST and keep business records.
Will the IRD accept your work situation as bona fide contracting or not?
Employers and employees cannot just choose to switch to a contracting arrangement. There are particular rules which the IRD, and ultimately the courts, apply to decide whether your relationship is one of a true contractor or a quasi-employee. An example is the ‘control’ rule. If the hirer can control when holidays are taken, or when, where and what hours are worked, as well as the work quality and the remuneration rate, then the relationship will be considered to be quasi-employment.
If you are forced by a current employer to move into a contracting situation that you feel is not bona fide, then try to ensure your employer understands the issue. If the IRD investigates you as the person claiming to be an independent contractor, the onus of proof and the possibility of penalties is as much on the hirer as it is on the contractor.
Can you charge enough to cover new costs?
Remember that once you’re self-employed, you no longer receive holiday pay, statutory pay or sick pay. To recover this loss, you need your charge-out rate to be at least 25% higher than your hourly rate as an employee, just to be earning the same. For example, if you currently earn $20 per hour as an employee ($40k approx), then you need to charge at least $25 per hour to be on the same money. My advice is that if you can’t achieve more than 25% you are better off as an employee.
Can you really extract the flexibility you want?
A lot of contractors find they just work more hours than they did as an employee and don’t get the flexibility they expected. One cause of this is that contractors’ hours can become less predictable.
The Good News
If you become a contractor you’ll join the ranks of the self-employed and this work status can give you advantages not open to an employee.
Once you are self-employed, you can claim business-related expenses against your income and hopefully reduce your tax liability. This is the reason that IRD are so hot on making sure that the person is in a true contract relationship, not just an employee being called a contractor. Costs such as home office expenses, vehicle expenses, mobile and home phones, office equipment etc can be claimed and offset against income. You are best to seek advice on what you can claim in your particular situation.
When you set up your contract, that is the time to write in the flexibility you want. Four day week? Leaving in time for the school run? By setting expectations at the outset, you
increase the chances you won’t lose this benefit of being a contractor.
Being able to work for more than one organisation can be a good reason to work as a contractor. You can use your skills and get exposure to different industries and people.
Handling the paperwork
If you don’t want to learn how to prepare GST returns or balance your books, then talk to your advisor. Most accountants today can offer a service of doing this work for you at a reasonable price.
Being a contractor can be very good as long as you are able to get a good rate, flexible hours, and you understand the tax rules for determining the true nature of a contracting relationship. I would also recommend you have your lawyer review your contract to ensure it is a viable contract. The information in this article is general information only and should not be relied on as advice by any person. For specific and informed advice please see your advisor.
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