Converting from Employee to Subcontractor

Changing your status from an employee to a subcontractor for the same shop is a complicated and potentially risky move. October 13, 2008

My husband currently works for a general contractor as an hourly employee. The owner asked him yesterday if he would agree to change from an hourly employee to a subcontractor, due to license fees, bonding, taxes, etc. being too high. My husband does the design, building and install for a residential custom furniture builder.

We want to make sure, before we jump in feet first, that this is the right move to make, financially, regarding liability matters, etc. We need some advice on contracts between the GC and the sub, to protect ourselves. We are located in Ohio.

Forum Responses
(Business and Management Forum)
From contributor S:
One thing is, as an hourly employee, you get some benefits, but as a subcontractor you cover your own. That is probably why he wants to change - so he doesn't have to pay benefits.

From contributor K:
And overtime and holidays.

From contributor B:
And insurance and workers comp.

From contributor D:
As a sub, you take all the risks on yourself, in exchange for the (potential) profit you can keep. It sounds like the employer is trying to transfer all the risks and expenses to you and your husband. You will need to cover your own expenses, health and liability insurance - everything the employer covers now. Not to mention employee, HR, and management issues if you have to hire help to do the job.

The really bad news is that the GC has told you your husband's employment is "too expensive" - meaning he is already thinking about eliminating your husband's position anyway.

Another disadvantage is that subs everywhere seem to have trouble getting money out of GC's. There are many GC's that take advantage of the subs and use them as low interest or interest-free banks, drawing out payment 90 days or longer.

The advantages of being a sub are controlling your own schedule, being able to work with other GC's and do other jobs, certain tax advantages for owning your own business, and potentially making more money. By any measure, this is a big decision.

From contributor J:
Classic bait and switch tactic. If you agree to switch to a subcontractor status, then your employer immediately loses all liability pertaining to your employment. Which means that he can then terminate your contractor/subcontractor status without having to worry about whether or not you will file for unemployment, etc. If you sit down and think about this for a moment you will quickly uncover your employer's true intentions. If, as an employee, he is unable to continue paying your salary because it is too expensive, why would he think that as a subcontractor you would be less expensive? Granted there are some labor burden issues that move from his plate to yours, but if you are properly pricing your service, your client (former employer) will still be paying them. On the other hand, you also have to examine the bigger picture. Is your husband's vocation such that he would be able to solicit other similar work from other contractors?

From the original questioner:
Yes, he could get other jobs from other GC's. He is really busy as it is and I would be worried about seeing him biting off more than he can chew, in essence making it hard for me to assist him and help handle the stresses he would face.

From contributor L:
See if there is a local office for the SBA. They might be able to meet with you and give some advice on that issue.

From contributor J:
One good exercise is to sit down and plan out a day. If your husband is capable of doing X amount of work in one day for one employer, how much more or less work could he do if he were a one-man show?

I see many good cabinetmakers who want to make a go for themselves. They have the skills to build a kitchen from start to finish. Word gets out about how such-and-such just went into business for himself. Before long, the phones are ringing and new orders are coming in. Then the scheduling problems start. Before long, there is such a backlog of jobs that customers get pissed off. There is no cash flow, because a job that a deposit was collected on isn't finished, so the customer is holding onto the balance. New employees magnify the problem because of training issues. The list could go on and on.

I knew of one drafter who went into business for himself. Within two weeks, he had contracted over 40 jobs. Problem is that he didn't understand budgeting and scheduling. His product was under-priced and his deposits were incredibly small. Within a couple of weeks he was broke. He simply didn't have the time to complete one job, much less 40 jobs.

From contributor S:
Aren't we a cheerful bunch? Unfortunately, it is all too true. It looks like you and your husband are being pushed towards starting your own company. Most of us here did it and lots more will do it yet. I have been in business for 25 years now, and I am glad that I did. That said, there were some extremely terrible times to go through, but we did manage to weather a multitude of storms and we are still here. You have to learn quickly to get a thick skin. Don't take it personally when customers complain about things you have no control over. If you mess up and don't deliver on time, then you can expect to hear about it. I wish you luck, but you must know it is not the easiest path to take.

From contributor G:
If your husband is making $20/hour now, he will have to charge $30 or more to have the same take-home pay. The GC will want to just pay the same per hour rate he is paying now. That will be a big pay cut for your husband.

From contributor T:
In addition to paying for your own business liability insurance, you will pay twice as high a rate of Social Security tax. Instead of the 7% withheld as an employee, you'll pay 14% as both employer and employee, or whatever it is. So you should expect a higher pay rate to cover these and other costs. As long as you're not incurring the overhead of a shop, being an independent sub is not necessarily a bad deal. I run a small shop and had a guy working for me for the last 2 years in that capacity. He had the luxury of taking off whenever he wanted to do other work, or long vacations. And I had the luxury of telling him when I didn't need him if things got a little slow. When business dropped off back in November, he (understandably) went and got a regular job, while I'm stuck with the overhead, working alone, and hopefully finding someone else when things pick up. So it's a two-way street. If you're the primary breadwinner, a slowdown (i.e. layoff) is very difficult unless you have some cash in reserve. Fortunately my wife works so I can manage for a couple months, and things have started to pick up already. Plus I get my health insurance from her employer - that's a huge cost factor to think about.

From contributor E:
If you become a subcontractor, you are in business for yourself, with all the added expenses and liability (you will have to be licensed), and perhaps the potential of extra profit, but it's a risk. As an employee, you have worker's comp and liability covered by your employer, and no matter how bad you screw up, the worst that can happen is you get fired. As a sub, your expenses for insurance, rent, health insurance, etc. all go on even if you have no work.

Your current employer is merely shifting liability and costs to you, and probably won't pay you the needed 50-70% to make it worth your while. Also, if you use his tools, or if he schedules your time, in California you are not a subcontractor, you are still an employee.

If self employed, it also becomes your dime to provide for a retirement too. It could work out fine, but you will need a lot of other customers in addition to your current boss. He wouldn't be dumping this on you if he was doing that well financially in the current case. I'd look for other work.

From contributor O:
"If your husband is making $20/hour now, he will have to charge $30 or more to have the same take home paid. The GC will want to just pay the same per hour rate as he is paying now. That will be a big pay cut for your husband."

Are you kidding me? If you are making $20/hr now, you will have to charge a minimum of $40/hr. And that is if you work out of your truck. If you need a shop, you will have to charge $60-$70/hr just to make enough to pay all the bills and make your wage and a small profit. I don't think you have looked at the picture that well. You will need all kinds of insurance, and there are fees, licenses, permits, taxes, and you get to pay the other half of the FICA, so instead of 7.5%, you get to pay the full 15%. Then you are going to need an accountant and possibly retain a lawyer, plus electric bills, heating bills, telephone bills. You have to spend time getting supplies and running around, which cuts into your "work" time. Expect to work an extra two hours a day and some weekends to make up for this.

Getting started up is a costly thing. Running the business becomes less costly as you go and learn all aspects of the business and no longer need your accountant and lawyers. If something goes wrong, guess whose money they are going to use to fix it? Yours. So if you think that $10 an hour is going to cover the business aspect of the business, you are not doing it legally. I am in Connecticut, so our pricing is outrageous. Maybe where you are located is cheaper, but it will still not be the $10/hr you speak of.

Either way, I was forced into the same situation. I started out with $22.50/hr 12 years ago and it wasn't nearly enough. Now I have my own shop and my own client and I still don't make a killing by any standard. I make a small profit and I usually burn that up by getting new tools to make my life easier. Eventually I will have all the tools that I need/want and can start on my bank account.

I hope the decision that you make works for you. But getting started is a tough thing to do. Especially with the housing market falling on its face like it is doing right now.

From contributor B:
Contributor O is right on. I have my own business as well. If I were starting out at this time with the housing market being what it is, I would be worried.

From contributor H:
If your husband becomes a sub to his former employer, along with what others have said in previous posts, he cannot do more than a certain percentage of his work for his former boss. He also cannot use his old boss's shop, tools, vehicles, materials or at any time be under his direct supervision.

From the original questioner:
Thank you for taking the time to give all of this great advice! The point about the housing market is so true. Here in Columbus, the industry is suffering and we can see the loss all over the city. I am setting up an appointment with a SB adviser, so we can decide if this is the right move.

From contributor P:
It's important to check with your accountant; if the plan is that your husband works the majority of the time with his former employer, he may end up being considered an employee anyway, as there is a fine line between employee and subcontractor as far as the IRS is concerned when most of your work is for one contact.

At a minimum, I would have your husband ask the employer to maintain his employment status and give your husband 90-120 days to get your ducks in a row to be able to transition to subcontractor, as he cannot rely on the former employer for all of his income once he becomes a subcontractor. If the employer cannot wait for 90-120 days for this transition, his situation may be dire...

Personally, if the employer is that concerned about insurance, etc. he has deeper problems to deal with and this might be a clarion call for your husband to find other employment.

Also, keep in mind that once your husband becomes a subcontractor, all those issues that the employer listed as the reasons for making the move now become your husband's to deal with - license, insurance (business/medical/dental/liability/auto), business filing, quarterly filing, taxes, social security, etc. - as well as finding the work to cover all these expenses. This does not include all the other issues that come with being self-employed including billing, sales calls, paperwork, late-pays, etc. (the list is quite long). Oh yeah, and that doesn't include doing the actual work itself.

Not trying to discourage your husband from striking out on his own, but there are so many aspects to running a business (even a one-man operation) that need to be taken into consideration that it's important to weigh all the pros and cons before taking the leap. The more prepared you are, the better... Contact your local SCORE rep, and meet with them to go over your thoughts. These are retired execs who do this for free.

From contributor L:
"Eventually I will have all the tools that I need/want and can start on my bank account."

Probably wishful thinking; at least it hasn't worked that way for me. I'll admit to being somewhat of a tool nut, but there is always something else I "need."

I agree with almost everything that has been posted. Getting started is not easy. Most people just starting out way under-price. There's a good reason small shops have to price at over $50/hr. I know I started out too cheap, may still be at $65/hr. If you can get the work, buy tools - they are cheaper than employees, and often more reliable!

From contributor M:
One of the major issues that hasn't been addressed is workman's comp and health care. What is your source of health care currently?

From the original questioner:
We have decided to not accept their offer to change to a sub. There are way too many holes in what they are telling us and no clear answers to our direct questions. The liability that we would take upon ourselves is not worth the risk in the long run. Personally we cannot put 100% trust in them to comply with any new agreements. Thank you to everyone who helped us with our decision - we couldn't have come to this conclusion without all of you!

From contributor I:
I want to reinforce the comment about the IRS's view regarding employees vs. subcontractors. I've been a custom woodworker for 30+ years. I've been employee, subcontractor, and business owner with both employees and subcontractors.

Is his current employer a general contractor (engaged in new construction and/or remodeling), or is he what we call here a specialty contractor (is licensed, bonded, and insured like a GC, but limited as to types and scope of work - like a plumber, carpet layer, or cabinetmaker)? Or is he strictly a manufacturer of custom residential furniture? Second - is the scheme for hubby to continue doing the same work, in the same building, answering to the same person... just change his "official" status?

From what you've described, the IRS would not accept the relationship as one of contractor/subcontractor. There are lots of rules and qualifiers and formulas, but your situation doesn't come close to meeting the standard. Your attorney or accountant can confirm that for you - and if you're considering going forward with this idea, you'll definitely need both.

There are a lot more questions to ask before I could advise you intelligently, so I'll read between the lines and make some assumptions. You don't say that being a small businessman is something hubby has yearned for. If it's not - do not go there. It takes a lot of extra work, dedication, and a good dose of bulldog stubborn to succeed as an undercapitalized small biz. If you're not passionate about it, and if your spouse isn't 100%+ on board, the stress can rip your life apart.

If hubby plans to continue to do some work for his current employer, and develop additional clients, just remember that being a small business owner is an entirely different career (that requires a bunch of different skills) than being a designer/builder/installer of custom furniture. Doing both jobs at the same time takes time. One thing I always tell folks is, "Owning the business is great. You only have to work half days... and usually you get to pick which 12 hours."

From contributor U:
The Internal Revenue Service has specific criteria for establishing status as an employee vs subcontractor. You must verify your status with them before making any agreement with an employer.