Switching from full-time employment to independent contracting or freelancing requires a fundamental shift in how you view your income. You cannot simply take your previous hourly wage and use that as your contractor rate. As a contractor, you are a business owner, responsible for costs that an employer previously covered.
The "Reverse Engineering" Formula
The most accurate way to set your rate is to work backward from your financial goals. Our Contractor Pay Rate Calculator uses the following logic:
Determine Net Income: How much money do you need to take home after all business costs and taxes?
Add Business Expenses: Software subscriptions, equipment, insurance, and marketing costs are tax-deductible but must be covered by your revenue.
Account for Taxes: As a self-employed individual, you pay both the employee and employer portions of Social Security and Medicare (Self-Employment Tax), plus income tax.
Calculate Billable Capacity: You cannot bill 40 hours a week, 52 weeks a year. You must subtract vacation time, sick days, and non-billable administrative time (marketing, invoicing, emails).
Why Your Contractor Rate Should Be Higher Than an Employee Wage
A common rule of thumb is that a contractor's hourly rate should be 2x to 3x the hourly wage of a comparable full-time employee. This markup covers:
Unpaid Time Off: You don't get paid for holidays or sick days.
Health Insurance & Benefits: You must purchase your own coverage.
Retirement Savings: There is no employer 401k match.
Job Instability: The premium compensates for the risk of gaps between contracts.
Overhead: Office space, internet, and professional fees.
Example Calculation
Let's say you want a net lifestyle income of $80,000.
Expenses: You estimate $5,000/year in software and insurance.
Taxes: You estimate an effective tax rate of 25%.
Workload: You plan to take 4 weeks off and can bill 30 hours a week (spending 10 hours on admin).
Step 1: Gross Revenue Needed
To keep $80,000 after 25% taxes, your pre-tax profit must be roughly $106,666 ($80k / 0.75). Add your $5,000 expenses, and your Total Revenue Goal is approximately $111,666.