The employee vs contractor decision involves more than hourly rate comparison. Employees cost more per hour on paper (employer overhead), but contractors cost more per hour in billing. The break-even depends on role, duration, and benefits cost.
The employee cost model
Full-time employee at $120,000 salary: - Salary: $120,000 - Employer payroll taxes: ~$9,500 - Health insurance: ~$12,000 (employer contribution) - 401k match (4%): $4,800 - Other benefits: ~$2,000 - Total: ~$148,300/year = $71.30/hour (on 2,080 work hours)
But effective working hours are lower. With 15 days PTO + 10 holidays: - 2,080 total − 200 PTO/holiday = 1,880 effective working hours - Effective cost: ~$78.90/hour of productive work
The contractor cost model
1099 contractor at $95/hour: - No payroll taxes (saves ~8% vs employee) - No benefits - No PTO - No equity vesting - $95 × 2,000 hours = $190,000/year (full-time equivalent)
The break-even calculation
Break-even hourly rate = Total employee cost / Hours worked
At $148,300 total and 2,000 billable hours: break-even = $74.15/hour.
If a contractor quotes above $74/hour, the employee is cheaper (long-term, full-time). If the contractor quotes below $74/hour, the contractor is cheaper.
When contractors are the better choice
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Short duration (< 12–18 months): employee setup costs (recruiting, onboarding, severance) don't justify employment for shorter engagements.
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Specific project: a 3-month website redesign doesn't need a permanent hire.
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Specialized skills: niche expertise that you'll use for a defined period.
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International work: contractors in lower-cost countries can deliver high quality at significantly lower fully-loaded cost.
When employees are the better choice
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Ongoing role: if you'll need someone continuously for 2+ years, the employment model becomes more cost-efficient.
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Core IP work: employees automatically assign IP to the employer. Contractors require explicit IP assignment clauses.
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Culture and management: employees are more integrated and easier to manage.
Use the Payroll Cost Calculator to calculate the exact employer cost for any salary scenario.