Impact of IRS rulings on contract writing

Subject: Impact of IRS rulings on contract writing
From: "M. David Orr" <whitears -at- INTERACCESS -dot- COM>
Date: Mon, 3 Mar 1997 17:25:37 -0600

Deborah Rech wrote:

>I am interested in finding out how tech writers working as independent
>contractors are affected by the recent decisions the courts have made
>against companies who have misclassified employees as independent
>contractors.

John Gough replied:

>IMO, the entire market was affected by the IRS rulings:
>1. It is now much more difficult to obtain independent work
> unless you own an incorporated business.
>2. Overall, contractors are being undercompensated
> due to contracting agencies working the fee spread.

>A side-affect of the IRS decision was an explosion in the number
>of contracting companies, who link employers with contractors.
>This has proven to be bad for individuals, because the contracting
>companies are motivated to maximize the spread between what
>they charge an employer and what they pay a contractor.
>A reasonable spread covers SS taxes, overhead, and a margin
>of profit. It should not exceed 20 to 30% of the amount charged
>the employer in most cases. Note that contracting agencies do
>not provide sick leave, vacation, health benefits, or savings
>plan benefits (some do if you have worked *continuously* for
>them for a minimum period of time, but the nature of contracting
>is short-term assignments).

>Examples of abuse:
> company charges employer $75/hr, pays contractor $22/hr
> company charges employer $55/hr, pays contractor $23.50/hr


OK, John, here is an owner's side of the story. I own a regional company
that brokers contract writers and also has staff writers. A few points:

1. Many writers feel the way you do. My wife felt the same way when she
worked once as a contract broker and found out she was getting only $23
an hr. while the broker was billing at $45 an hr. Outrage! Unfair! I
felt the same way when I worked for a broker.

For the first four or five years of my 11-year-old brokering enterprise,
we marked up 25% to 30% above cost. My average pre-tax profit was about
3% to 5% during the years we made money and minus God-knows-what during
the lean years. Plus, I made less money than I made as a contractor
working for others at "unfair" wages. We couldn't afford to grow as fast
as we would like and had to borrow money to grow. All our money went
back into the business to service debt. We couldn't provide adequate
benefits and couldn't spend much on training and career development.
Forget a good facility and good working conditions. A friend accused me
of running a welfare agency for writers.

Now we mark up 43% to 50%. With these margins we make 5% to 8% pre-tax
profit in a good year and still lose God-knows-what in bad years. We do
grow now more easily; we have a better facility to work in; we have
nicer marketing materials;we do research and development to improve our
craft; we are able to recover from debt and bad times more quickly
because our margins are better. We are more likely to survive and keep
the 10 to 40 contractors we employee, plus our staff, busy.

2. Average service business margins are at least 40% to 50%. Large
accounting firms may bill 2 1/2 times their cost. Larger firms tend to
spend more on sales and marketing.

3. Hidden costs, not so well seen by contractors, include

* Cost of marketing and sales (around 10%-15% in our company)
* Administrative costs (administrative salaries and benefits for
management, accounting, reception, and administration, office supplies,
training, internal documentation, equipment, rent, utilities, etc. - 15%
to 25%)
* Direct and indirect project costs (5%)
* Costs associated with time spent "on the beach" (unbillable time) by
employees (varies from year to year but amounts to about a month per
employee)
* Project losses and adjustments (A contractor has work rejected by a
client; company has already paid contractor; but company doesn't get
paid. In a recent year, we had one project that costs us $35,000.)
* Interest expense on line of credit (We pay contractors twice a month,
clients agree to pay in 30 days, but actually pay in 45 to 60 days. The
bank lends us the difference at Prime plus 1%. This amount can add up to
1% or 2% of our gross in a year.)
* Taxes (We pay taxes just like everybody else, except they come off the
bottom line.)
* Debt retirement (After making a profit and paying taxes, most of the
money goes to debt retirement. Some goes to the owners' 401K and to our
child's education.)
* Profit sharing and bonuses (We share about 10% of profits with
employees, including contractors that qualify for our 401K by working
more than 1000 hours in a year. We don't take it back during bad years.)

John is right that his labor generates income, but the writer doesn't
work in a vacuum--others are selling, managing accounts, collecting
bills, paying bills, greeting people, answering phones, paying expenses,
and taking financial risks so that the writer can work. A true
independent contractor who does his/her own marketing, administration,
and financial risk-taking deserves the additional money that comes from
working directly with a client instead of through a broker.

The IRS forces us to use W-2 temporary employees on most projects
because of the guidelines they have. We prefer 1099 relationships, but
they are gone with the wind for the most part. We pay W-2 temporary
employees much more on an hourly basis than our staff people. The rates
we pay are equivalent to our staff rates plus the amount benefits would
cost plus about a $5 per hour premium for no job security (a myth, this
job security).

Fair? I think so, but what do I know. I'm just a greedy, swamp-running,
no-count, sock-sucking, capitalist pig. Oh, and I'm from Chicago too,
along with Al and all the other St Valentine's Day crowd. Rat-a-tat-tat!

>Overcharges by middlemen hurt both the employer and the contractor:
>--the employer gets less employee than they are paying for
>--the contractor, who does the work, does not receive fair compensation

What the employer gets is 1) a buffer from the wrath of the IRS 2)a
company with assets to stand behind the contractor in case work is not
accepted, 3) a company that can replace a contractor quickly if s/he
becomes ill or otherwise unavailable 4)other value-added tools and
free-bee consulting, 50 a company that has the financial resources to
finance larger projects, 6) someone they can vent to about their
company.

>Some larger corporations are now mandating a maximum spread, to keep
>from getting low-level employees at sky-high prices.

This works fine in a buyer's market, but what happens when most
contractors are booked up or the client requires a special and rare
skill? Artificial price controls usually result in a shortage or the
desired item. (I know, writers are people not items.)

>I am in favor of a free market. A market that operates by concealing
>information, intimidating the people who perform the work, and >squeezing out competition on a basis other than performance, is not >free.

A free market is free--period. Behaving the way you describe is one
strategy. Believe it or not, brokers have to compete with each other for
writing talent. I hate it when we need five writers and can find only
three suitable ones. We compete by keeping our paying rates at a
reasonable level, by disclosing rates and mark-ups, and by treating
writers decently. We've managed to stay in business for 11 years, so the
strategy seems to work. The idea of a free market is to drive out bad
ideas without a lot of regulation.

>I know that some of the list lurkers are agency reps or agency owners.
>Let's hear *your* side of the story.

I do NOT lurk. Isn't that a great word--lurk, luuurk, luuuuurk. It's
really sinister, especially when applied to greedy, capitalist running
dogs.
--
M. David Orr
Orr & Associates/Usability Management
7366 N. Lincoln Ave. Suite 101
Lincolnwood, Illinois 60646, USA
Phone: 847-677-1920
Fax: 847-677-7878
Email: whitears -at- orrnet -dot- com
Web: http://www.orrnet.com

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