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Going from Employee to Contractor
any tips to help me avoid mistakes?

 9:50 pm on Dec 29, 2010 (gmt 0)

I recently relocated from Alaska to Hawaii for health reasons, and have been working from a home office for the same company that I worked for in Alaska.

Yesterday, I was informed that due to "Nexus", the company in Alaska would be forced to pay taxes in Hawaii if I were to remain an employee. So, we are in the process of working out an arrangement where I will be a private "contractor" instead of an employee, performing the same duties.

Have any of you gone through a transition like this? I'm curious whether I should form a Sole Propriety or LLC (or S-Corp), whether I need to register my business in Hawaii-or if it's advantageous/legal to register elsewhere.

I'm also not sure how the compensation should be structured, as I'm going from a 40/hr work week with salary+ comission, health insurance, and 401K to... ?

The health plan and 401k will be gone (fully vested 4% match)

I want to avoid any early mistakes that could bite me in the future, and hopefully turn what could be a negative into a positive.

Advice, stories, and experiences welcome!



 10:18 pm on Dec 29, 2010 (gmt 0)

My personal advice is to form a company. (You should definitely talk to a local lawyer & accountant and have your personal situation reviewed- it's not a one-size-fits-all kind of topic. They can help set things up so that you can take full advantage of relevant deductions.) Being a sole prop contractor (especially when you were previously an employee) can raise some eyebrows. Going corp-to-corp seems to smooth away most questions. If possible, your company should have other clients to help it look more legit. (It sort of depends on what business you're in.)

If you're working in Hawaii, you'll most likely need to register in Hawaii. Even if you register your company in another state (Delaware and Nevada are common), you'd probably still need to register as a "foreign" corp in Hawaii.

Compensation should definitely be more, since you'll be paying 100% of your share of FICA/Medicare (employers pay 50%) plus unemployment insurance. You'll also need to get your own health insurance. Setting up a 401K (or SEP-IRA) is also something you should do soon.

Remember that the company's contributions (matching or otherwise) are tax deductible. So if at the end of the year the company has a $10,000 profit, it can either pay the tax on that $10,000 or put it into your 401K. Also remember that the company has until the tax return due date to actually make the payment into your 401K. (The specifics of this and other related issues can be explained in more detail by your accountant.)


 10:19 pm on Dec 29, 2010 (gmt 0)

I will be a private "contractor" instead of an employee, performing the same duties.

There have been a lot of legal interpretations over the past few years as to which instances a "contractor" is actually acting as an employee because of the contractor's duties, frequency of duties, actual independence, etc. Before you do anything else it would probably be best for you and your "client" to get a legal opinion as to whether your contractor status would be able to be challenged in any way and, if so, what the implications would be for both sides.


 12:12 am on Dec 30, 2010 (gmt 0)

This is very helpful-Thank You!

Being a sole prop contractor (especially when you were previously an employee) can raise some eyebrows. Going corp-to-corp seems to smooth away most questions.

LIA- Can you please clarify this? Are you referring to the ominous eyebrows of the IRS?


 12:26 am on Dec 30, 2010 (gmt 0)

The IRS and the local government agency related to employment issues (in California it's called the Employment Development Department).

There is a lot of abuse with ICs- many companies call employees ICs when they are, in fact, employees. Just calling them ICs to avoid payroll taxes, unemployment insurance (or unemployment claims if they change their status just to fire them).

But if the IC actually does work for another company, there's a paper trail to back it up.

One other issue is that it can also cause some problems if a company has some regular employees and some ICs performing the same jobs. I thought I read somewhere that said that was an absolute no-no; you have to have either all employees or all ICs. (Can't remember where I read it, so I'm not going to state it as a fact.) Another option would be to be a "leased employee" instead of an IC (think of it as a long-term extension of using a temp agency). It's basically the same as an IC, but a little bit more formal arrangement. For example, the EDD has some specific guidelines [edd.ca.gov]. California does not specify that the leasing company be a registered temp agency or employee leasing company, but other states may have different requirements.

Again, consult a local legal/tax specialist for the best advice. There may be some differences in Hawaii (or Alaska) for requirements or taxation in the different scenarios.


 5:19 pm on Dec 30, 2010 (gmt 0)

Thanks for the clarification. Looks like I'll be forming an LLC registered here in Hawaii (unless someone recommends a better course of action). I'll speak to a tax specialist.

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