Re: Impact of IRS rulings on contract writing

Subject: Re: Impact of IRS rulings on contract writing
From: John Gough <gough -at- AUSTIN -dot- ASC -dot- SLB -dot- COM>
Date: Wed, 5 Mar 1997 14:54:38 -0600

I missed David Orr's post; Rob Johnson was kind enough to
forward it to me. At the outset, thanks to David for writing
an extended reply. I also think that the type of company you
are attempting to grow is great! R&D? Benefits? Bench time?
Cool. You disclose your spread? Then I have no complaint
with you.

Now on to the long section of the reply.

1. Writers--get your agencies to disclose rates and spreads. Make
a scary looking form for them to fill in (it should include notice
that falsifying the information is fraud and subject to criminal
and civil action).
2. Agencies--disclose your rates and spreads. The market will determine
your mix of rate paid and services is a good one.
3. IMO, David hasn't convinced me that contractors live in a better
world since the IRS ruling. Employees typically have less
leverage than corporations, so *they* get squeezed.
4. Agencies do serve a purpose. IMO, without the IRS ruling there
would be fewer agencies, because now a certain percentage of
contractors are effectively prevented from competing as

David makes a good case. However, his is not a typical agency.
Most agencies I have dealt with are not attempting to grow
David's kind of business. They are "body shops," pure and simple.
They do not provide any benefits or equipment or even a place to work, as
David seems to do.

>1. <snipped> David talked about his margins.

Let's see, to take the low side, 3% of 25 writers at $50/hr
billed is about $75,000 when you're all done (before taxes,
to be sure) on about $2.5 million. That doesn't seem like
small change to me. Is David trying to tell me he runs a

I don't want to get into a discussion of margins. There is
a hidden assumption that every cost is necessary. Business
owners get benefits from the use/enjoyment of business assets
that are treated as costs.

Let's understand that agencies and contractors are both
businesspeople with potentially conflicting interests:

- An agency owner is in the business of providing
services (mo' and better). He needs bigger margins to cover
various enterprises. Diversity typically plays better in a market.
He also wants to play up his enterprise as a "service" to
contractors, too.

- A contractor is in the business of providing services, too.
He may want the minimum markup on his services, especially if
he's a specialist or highly experience. He wants fewer services
and more money.

>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.

I'm not sure I'm willing to accept comparisons to the average
service business. The average service business has employees
(and higher fixed costs as a result).

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

The "typical" agency I describe does have the marketing, administrative,
loss risk, and direct costs (rep time). David's agency is unusual
in that it provides work space, profit sharing, and bench time.
I don't know about the debt for payroll; you could avoid it
by increasing working capital (assuming you don't have a better
use for it).

>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.

Agreed. But how much agency do I need? I'd rather build my
own capital base than pay for an agency's fancy offices.

As for taking risks as an independent, the thing that really burns
me is that I don't have the choice. The IRS effectively closed a lot of
independent contractors out of the market. I have to become a corporation
or work for one. That's a *big* difference. IMO, the IRS created an
artificial demand for agencies.

>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).

Job security? In the computer industry? hahahahahahahahahahah

The cost basis of benefits is fairly interesting. The conventional
wisdom is that it accounts for 30-50% of salary in costs. If
I buy my own and assume only slightly more risk, medical only
costs 8-10% (that's premiums plus direct medical costs).
Unemployment benefits I don't get, but I don't have to pay the
premiums either. Smaller may be more efficient--if you're healthy.
Being part of a larger agency means funding things that you don't
necessarily enjoy (dependant benefits, for example).

>Fair? I think so, but what do I know. I'm just a greedy, swamp-running,
>no-count, sock-sucking, capitalist pig.

Oh, get a grip. It would be more fun to discuss business if business-owners
didn't wave the "communist! anti-business! anti-jobs! anti-American!
child-molester-atheist-sodomite!" banners every time someone critiques
an issue. My opening remarks included my belief that an agency is
entitled to cover their costs and make a profit. Anyway, I'm an
oinker too.

>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

Let's not forget (a) a two-tier class of employees, which they must
keep client recently went through a purifying spasm that
included scolding managers for including contractors on email mailing
lists and taking back all of the company-provided nameplates from
contractors, (b) risk that the agency will be even worse than the
client at picking employees, (c) risk that a contractor will walk
the contract, incurring additional costs of work procurement

>>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 consider the IRS ruling both a form of artificial market manipulation
and a reduction of my status from entrepreneur to "item."

>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.

Yes, and the _idea_ of the IRS was to better the treatment of employees,
but as I said before, I don't think it worked out that way. They
just ended up cutting a step off of the entrepreneurial ladder.
Now you (David) don't have to compete with me, because I am prevented
from competing. The IRS said I couldn't (well sure I could, but the
IRS artificially raised the cost of entry and is threatening companies who
dare use me).

All in a good day's fun,

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