An employer offers you $120,000 as a salaried employee. A client offers you $120,000 as a contractor. These are not the same offer, and the gap is larger than most people estimate.
The single biggest line is self-employment tax. An employee on $120,000 pays $9,180 in Social Security and Medicare. A contractor earning the same $120,000 of net profit pays $16,955 — a difference of $7,775 before anything else is considered.
That is roughly a 6.5% pay cut, from one line item, and it is invisible to most employees because the half their employer pays never appears on a payslip.
This article works through that arithmetic properly, then covers the four costs that arrive after it — which together usually matter more than the tax does.
A note before you start. This is general education, not tax or financial advice. Federal figures are tax year 2026, from IRS Revenue Procedure 2025-32 and the Social Security Administration; self-employment tax figures are computed by this site's own engine following the Schedule SE structure. The comparison assumes a single filer with $120,000 of W-2 wages against $120,000 of net self-employment profit — a deliberately simple case, since real contracting involves deductible business expenses that reduce net profit and therefore the tax. Worker classification is a legal question with statutory tests, and this article does not address whether a given arrangement is properly classified.
1. The arithmetic
What an employee pays
FICA has two components and an employee pays half of each:
| Employee share | Employer share | |
|---|---|---|
| Social Security | 6.2% | 6.2% |
| Medicare | 1.45% | 1.45% |
| Total | 7.65% | 7.65% |
On $120,000, the employee's share is $9,180. Their employer pays another $9,180 that the employee never sees.
What a contractor pays
A self-employed person is both the employer and the employee, so they pay both halves: 12.4% Social Security and 2.9% Medicare.
But two statutory adjustments apply, and both are real:
First, only 92.35% of net earnings is subject to the tax. 26 U.S.C. 1402(a)(12) excludes the portion representing the employer-equivalent half, so you multiply net profit by 0.9235 first.
Second, half of the resulting tax is deductible above the line against your income tax, under 26 U.S.C. 164(f).
Worked through on $120,000 of net profit:
| Amount | |
|---|---|
| Net profit | $120,000 |
| × 92.35% | $110,820 |
| Social Security at 12.4% | $13,741.68 |
| Medicare at 2.9% | $3,213.78 |
| Total self-employment tax | $16,955.46 |
| Deductible half | $8,477.73 |
The comparison
| Employee | Contractor | Difference | |
|---|---|---|---|
| Payroll tax on $120,000 | $9,180 | $16,955 | +$7,775 |
The ratio is about 1.85x, not 2x — the 92.35% factor is doing real work. But $7,775 is $7,775.
What that means for a rate
To match the employee's after-payroll-tax position on $120,000, a contractor needs roughly $128,000 — and that is only the tax. It ignores everything in the next section.
Compare an employee salary against your state's own tax rules2. The Social Security cap changes the shape
Social Security stops at the wage base — $184,500 for 2026 — while Medicare never stops. This means the self-employment penalty is not a constant percentage: it is largest for middle incomes and shrinks proportionally at high ones.
Below the cap, the contractor pays an extra 12.4% + 2.9% minus the employee's 7.65%, on 92.35% of earnings. Above it, only the Medicare portion continues, so the marginal gap narrows sharply.
Practically: a contractor earning $80,000 feels this far more, relative to their income, than one earning $400,000. If you are comparing offers well above the wage base, the self-employment tax difference is a smaller share of the decision than it appears from the headline rates — and the benefits gap in the next section becomes proportionally larger.
3. The four costs after the tax
Self-employment tax is the number people compute. These are the ones that decide it.
Health insurance
Usually the largest single gap, and the most commonly omitted. Employer-sponsored coverage is subsidised — employers typically pay a substantial majority of the premium for an individual, and often a smaller but still large share for a family.
A contractor buys their own, either on the individual market or through a spouse's plan. The self-employed health insurance deduction exists and helps, but it does not replace an employer subsidy — it changes the tax treatment of a cost you are now bearing in full.
Get the actual number before comparing offers. Ask your current employer what they contribute toward your premium; it is on your benefits statement. Then price equivalent coverage yourself. This figure is frequently five figures annually for a family and it swamps the tax difference.
The retirement match
If your employer matches 4% and you earn $120,000, that is $4,800 a year of direct compensation that stops. Not a benefit in the vague sense — cash, deposited on your behalf, that simply ends.
Contractors have genuinely good retirement options — a Solo 401(k) allows both employee and employer contributions and can shelter far more than a standard workplace plan. But the match is gone. You can contribute more; nobody is adding to it.
Paid time off
A salaried employee earning $120,000 with three weeks of paid leave and ten holidays is paid for roughly 25 days they do not work — about 10% of the working year.
A contractor billing hourly earns nothing on those days. If you plan to take the same time off, your effective rate must cover it. Billing 47 weeks instead of 52 means your rate needs to be roughly 10% higher to reach the same annual figure.
Unemployment insurance and the rest
Contractors generally do not pay into, and generally cannot claim, state unemployment insurance. They typically have no employer-provided disability or life cover, no workers' compensation, and no severance expectation.
The value of these is hard to price and easy to dismiss until the moment one matters.
4. What contracting genuinely gives back
An honest comparison runs both ways, and there are real advantages that are not merely lifestyle.
Deductible business expenses. This is the largest and most legitimate offset. A contractor's tax is charged on net profit, not gross receipts. Genuine business expenses — equipment, software, professional development, a qualifying home office, business travel, professional insurance — reduce the figure that both self-employment tax and income tax are charged on. An employee cannot deduct unreimbursed employee expenses at all under current law.
This matters more than most rate comparisons acknowledge. $120,000 of receipts with $15,000 of legitimate expenses is $105,000 of net profit, and the self-employment tax falls accordingly.
The qualified business income deduction. Section 199A allows many pass-through businesses to deduct a portion of qualified business income, subject to income thresholds and business-type limitations that are genuinely complicated. It can be substantial, and whether you qualify is a question for a tax professional rather than an article.
Larger retirement shelters. A Solo 401(k) permits an employee deferral plus an employer contribution from the same business, which can far exceed what a standard workplace plan allows.
Rate leverage. Contractors can typically raise rates with new clients faster than employees can get raises, and can serve several clients at once.
5. Quarterly estimated tax: the operational trap
Employees have tax withheld each pay period. Contractors do not, and the obligation does not wait for April.
The US tax system operates on a pay-as-you-go basis. Self-employed people generally must make quarterly estimated tax payments, and missing the schedule triggers an underpayment penalty even if you pay the full amount by the filing deadline. Paying on time and paying in full are two separate requirements.
Two practical consequences:
Set money aside from every payment received. A reasonable starting reserve is 25–30% of net profit for federal income tax plus self-employment tax, before state tax. Money in your account is not money you have earned until the tax is provisioned.
Understand the safe harbour. Penalties are generally avoided by paying either a specified percentage of the current year's liability or a percentage of the prior year's, whichever route you choose — the thresholds are set in the regulations and are worth confirming with a professional for your income level, since a higher prior-year income changes which is available.
For anyone leaving employment mid-year, the first year is the awkward one: your prior year was fully withheld, and your new income is not. That is the year to get advice rather than guess.
6. Building a rate that actually matches
Working from a $120,000 salary, the components to cover:
| Component | Roughly |
|---|---|
| The salary itself | $120,000 |
| Extra self-employment tax | +$7,775 |
| Employer health contribution you are replacing | + your actual figure |
| Retirement match lost (4% example) | +$4,800 |
| Unpaid time off (3 weeks + holidays) | +~10% of the total |
| No unemployment or disability cover | + a judgement call |
Before health insurance, that is already meaningfully above $140,000. With a family health premium it can be well beyond.
Then subtract whatever your genuine deductible business expenses come to, since they reduce the taxable base — and note the qualified business income deduction if you qualify.
The rule of thumb that contract rates need to be substantially above salary is not contractor folklore or negotiating posture. It is what falls out of adding these lines up.
One thing not to do
Do not compare an hourly contract rate to your salary divided by 2,080 hours. That comparison omits every line above, and it is the single commonest way people take a contract that pays less than the job they left while believing it pays more.
7. The transition year is the awkward one
If you leave employment partway through a year, the first twelve months have their own problems and they are mostly about timing rather than totals.
Your withholding stops but your liability does not. Through your employed months, tax was withheld from every paycheck. From the day you start contracting, nothing is withheld and the responsibility moves entirely to you — including, from that point, the estimated payment schedule.
Income is lumpy and the schedule is not. Contract payments arrive when clients pay, which is frequently not when you invoiced. Estimated tax is due on a fixed calendar regardless. The gap between those two rhythms is what catches people, and it catches them in a quarter where a large invoice has not landed yet.
The safe harbour question changes. The rules let you avoid an underpayment penalty by paying a specified share of either the current year's liability or the prior year's, and which route is available or advantageous depends on your prior-year income. Someone who has just left a well-paid job may find the prior-year route demanding, since it is measured against a full year of salary. This is genuinely worth an hour with a tax professional in your first year rather than a guess.
Set the reserve up before the first payment arrives. A separate account, and a fixed percentage of every payment moved into it the day it lands — 25–30% of net profit for federal purposes, plus your state's rate. Money that has already been swept is money you will not accidentally spend, and the alternative is finding the tax in April out of whatever happens to be left.
8. A checklist before you sign a contract
- Get your employer's health contribution in writing. It is on your benefits statement, and it is usually the biggest single line in this comparison.
- Price equivalent coverage yourself on the individual market or through a spouse's plan.
- Add up what you lose: the retirement match, paid leave and holidays, disability and life cover, unemployment eligibility.
- Compute the self-employment tax on the offered rate rather than the rate you hope to reach.
- Estimate your genuine deductible business expenses — equipment, software, professional development, a qualifying home office, professional insurance. These reduce net profit, and therefore both taxes.
- Decide how many weeks you will actually bill. Fifty-two is not the answer; 46 to 48 is realistic once holidays, illness and gaps between clients are counted.
- Confirm payment terms and late-payment provisions. Net-60 terms turn a good rate into a cash-flow problem, and a contract without a late fee gives you nothing to point at.
- Ask about the classification test if the arrangement looks like employment in substance — set hours, a single client, their equipment, their direction. Misclassification is a legal exposure for both sides, and calling someone a contractor does not make them one.
9. The case that is genuinely better as a contractor
An honest treatment should say where the contractor comes out clearly ahead, because it is not rare.
Multiple clients at a rate no single employer would pay. Specialist skills often price higher by the hour than any one employer will pay as salary, and serving three clients diversifies the risk that made the employee job feel safe. Losing one client of three is a bad quarter; losing one job of one is unemployment.
Substantial legitimate business expenses. Where the work genuinely requires equipment, software, travel or a dedicated workspace, those costs come off net profit before either tax applies. An employee bearing the same costs cannot deduct them at all.
Coverage from elsewhere. A spouse's employer plan removes the largest single line in this comparison. That changes the arithmetic more than anything else on the list, and it is why an identical offer can be clearly good for one person and clearly bad for another with the same skills.
Retirement capacity you would actually use. A Solo 401(k) permits both an employee deferral and an employer contribution from your own business, sheltering far more than a standard workplace plan. This is an advantage only if you have the income to fill it — for someone who does, it is a large one.
Control over volume. Taking on more work in a good year, or less during a period that demands it, has real value no salary offers.
The conclusion is not that contracting costs more. It is that contracting costs a specific, computable amount more in tax and lost benefits, and whether the rate plus the other advantages covers it is a question with a number attached. Work out the number rather than the feeling.
Frequently asked questions
How much more tax does a contractor pay? On $120,000 of net profit, $16,955 in self-employment tax against $9,180 of employee FICA — a $7,775 difference, or about 1.85 times. It is not quite double because only 92.35% of net earnings is subject to the tax.
Why is it 92.35% and not 100%? 26 U.S.C. 1402(a)(12) excludes the portion of earnings representing the employer-equivalent half of FICA, so that a self-employed person is not taxed on money an employer would have paid separately. It is a statutory adjustment, not an estimate.
Is half of self-employment tax really deductible? Yes, above the line under 26 U.S.C. 164(f). On $120,000 of net profit that is about $8,478 off your income — which reduces income tax, not the self-employment tax itself.
What contract rate matches my salary? Start with the salary, add the extra self-employment tax, add what your employer contributes to health insurance, add any lost retirement match, and add roughly 10% for unpaid time off. Then subtract your genuine deductible business expenses. It is usually well above the salary figure.
Do I have to pay tax quarterly? Generally yes. The system is pay-as-you-go, and an underpayment penalty can apply even if you pay in full by the filing deadline. Set aside 25–30% of net profit for federal purposes before state tax, and get advice on the safe harbour thresholds in your first year.
Does the self-employment tax gap shrink at high incomes? Proportionally, yes. Social Security stops at the $184,500 wage base for 2026 while Medicare continues, so the extra burden is largest for middle incomes and narrows above the cap.
Can I deduct expenses as an employee instead? No. Unreimbursed employee business expenses are not deductible under current law, which is a genuine and often-overlooked advantage of contracting — the tax is charged on net profit after legitimate business costs.
Does any of this decide whether I'm legally a contractor? No. Worker classification is a separate legal question with statutory tests applied by the IRS and state agencies, and it does not turn on what the contract calls you. If the arrangement looks like employment in substance, that is worth professional advice.
What to do next
The comparison is worth doing with your real numbers, and the health insurance figure is the one to go and find rather than estimate.
- Take-home pay calculator — what the employee side actually leaves you, in your state.
- Your Paycheck in the USA in 2026 — the full federal and state picture, including self-employment tax.
- Emergency fund calculator — contractors need more runway, and it should be sized on essential spending.
- 50/30/20 budget calculator — irregular income makes the budget harder, not optional.
- Salary calculators by state — all fifty states.
Every figure on this site is sourced and dated. How we source every number.
Figures in this article are illustrations computed by this site's own engines for tax year 2026, comparing $120,000 of W-2 wages against $120,000 of net self-employment profit for a single filer. Real contracting involves deductible business expenses that reduce net profit and therefore the tax. Federal figures come from IRS Revenue Procedure 2025-32 and the Social Security Administration. The qualified business income deduction, worker classification, and estimated-tax safe harbours all involve rules beyond this article's scope. This is general education and not tax advice; for your own situation consult a licensed tax professional.