How to Calculate Your True Hourly Rate as a Contractor

Why Your Billable Rate Isn't Your True Hourly Rate

If you bill clients at $100/hour, you do not earn $100/hour. Before you've taken home a single dollar, that $100 is reduced by self-employment tax, business expenses, unpaid time between and during contracts, and health insurance costs. For most contractors, the true hourly rate — the rate that reflects actual dollars earned per hour of total time invested — is 30–50% lower than the billing rate.

Knowing your true hourly rate is essential for: setting rates that actually work financially, comparing contractor vs employee offers accurately, and understanding whether your business is actually profitable. Use the W-2 vs 1099 calculator to see the full comparison with your numbers.

Step 1: Calculate Billable Hours Per Year

You cannot bill 52 weeks × 40 hours = 2,080 hours. As a contractor, significant time is non-billable:

• Vacation and sick days: 3 weeks = 120 hours unpaid (vs paid for W-2)
• Holidays: 10 days = 80 hours unpaid
• Between contracts (gaps): 1–4 weeks of searching, negotiating, onboarding per year ≈ 40–160 hours
• Administrative time: Invoicing, accounting, taxes, business development ≈ 2–5 hours/week = 100–250 hours/year

Conservative estimate for a typical contractor: 1,600–1,700 billable hours per year versus a W-2 employee's full 2,080 paid hours.

Step 2: Deduct Business Expenses From Gross Revenue

Your gross billing is not your net income. Common contractor business expenses:

• Health insurance: $500–$1,500/month for individual or family coverage ($6,000–$18,000/year)
• Software and tools: IDE subscriptions, project management, accounting software, cloud services ($500–$3,000/year)
• Hardware depreciation: Amortized cost of computer, monitors, peripherals ($500–$1,500/year)
• Professional development: Courses, certifications, conferences ($500–$3,000/year)
• Home office: Proportional share of rent/utilities for dedicated workspace ($1,000–$4,000/year)
• Accounting/legal: CPA to file Schedule C and quarterly estimates, contract review ($500–$2,000/year)

Total business expenses for a typical solo contractor: $10,000–$30,000/year. These reduce your taxable income but are real cash outflows that reduce your effective earnings.

Step 3: Account for Self-Employment Tax

SE tax (15.3% of 92.35% of net income) is applied after business expense deductions. For $120,000 net income after expenses, SE tax is approximately $16,956. You can deduct half (about $8,478) from income, saving approximately $1,865 in federal income tax at the 22% bracket. Net SE tax cost: approximately $15,091.

Step 4: Calculate True Hourly Rate

Putting it all together with a worked example — a contractor billing $100/hour:

A contractor billing $100/hour, after all taxes, business expenses, and unpaid time, takes home the equivalent of approximately $49–$55/hour of total time invested — not $100. This is the number to compare against a W-2 salary's equivalent hourly rate.

Setting Your Rate Correctly

Work backward from your target take-home. If you want to net $85,000 after taxes, work through the calculation in reverse:

• Target net after-tax: $85,000
• Add back estimated taxes (30% effective all-in): divide $85,000 by 0.70 = $121,400 pre-tax income needed
• Add business expenses: $121,400 + $18,000 = $139,400 gross revenue needed
• Divide by billable hours: $139,400 ÷ 1,680 hours = $83/hour minimum billing rate

At $83/hour billable, this contractor achieves $85,000 in after-tax take-home. Billing at $70/hour would net approximately $71,000 — a meaningful shortfall from target.