Feast or Famine…or Taxes! for the Consultant

Starting Your Own Contract Consulting Business


SC&C Consulting Business AdviceExample One: Dick

Striking out on your own seemed like such a good idea! Those first contracts were pretty good – they paid nearly twice what you were getting at your old job. It took almost all of your time, and the project creep found you doing a lot more work than you thought would be necessary.

But now that job is over and you don’t have a contract lined up. You had better find something fast. There are bills to pay, and suddenly you’re thinking maybe you should have held off on buying the new Prius, even though it is really cool.

Example Two: Mary

Ah, the easy life! Lunar Hotels Inc. was lucky to get me. I’ve done all the heavy lifting for this contract, and now I just travel from site to site and do a little firefighting a couple of times per week. Maybe I’ll just keep this contract going until I retire.

Wait, what do you mean I can’t claim rent, mortgage interest, land tax, payments to associates for support work, or expenses for more than one vehicle? Those are legitimate expenses!

How sad! These are two classic mistakes for proto-consultants just starting out and unfortunately these neophytes didn’t have a kindly advisor to point out these pitfalls. But youre not going to make those mistakes, are you?

But What Were the Mistakes?

SC&C Freelancer AdviceIn example one we see the classic, youthful excitement of Dick heading out on his own. Doinit the way it should be donewith a handshake and mutual respect!

This young man got some consulting leads from friends and associates and did a really super job. He excelled in every aspect. But somehow the parameters for the job kept changing; there were additional responsibilities. Dick had to dedicate more and more time to the job but the fees weren’t reflecting the additional work.

Dick’s other jobs were suffering for it, but it was taking everything he had just to keep up. And suddenly all the jobs wound down and the income ended. Dick has been so busy working that he spent no time lining up the next job.

In example two we see Mary who walked into or created a seemingly perfect arrangement. The first bit may have been hard, but now it’s the downhill portion of the roller coaster. She’s got a substantial income that is steady and reliable, and the work is well within her capabilities. The contract is on perpetual renewal until one of the parties terminates it, and Mary always gets her weekly fee.

Come tax time, however, Mary is about to make a horrifying discovery! She is now the latest victim of the Personal Services Income (PSI) Provisions of the Tax Act.

What Are the Solutions?

In example one Dick needs to get his head out of the clouds. It may make you feel good to be open, honest, and above board, but the road to hell is paved with good intentions. He developed an immediate focus and the long-term objectives became blurred.

You must have a contract that spells out your obligations in detail, that shows when you got paid, that specifies successful milestones, and that clearly indicates when the job is done. If additional work is needed, that is a new contract, separate from the existing one. It protects both of the parties in the contract. You have to do what you said you’ll do; they can’t arbitrarily redefine what constitutes success or requirements.

Meredith Little in IT Consultant, March 28, 2009, suggests: “If the work is clearly out of the scope of the contract, you can say to your client, “No problem. I’ll write up a contract addendum and cost proposal for your review.” When the client realizes that the change is going to cost more money and take more time, they may decide they don’t want it. Or, they may accept your offer and pay for your extra work.”

He also must manage his time so that he is looking for the next job while he is still working. It’s easier to get a job when you have a job. People hire busy people, not unemployed people. If you can say “I have a spot coming up in May with a fairly large window of time that ought to suit your purposes” rather than “Sure, I can start right now, if you like” you will be called upon more often.

What about Mary?

Ah, the latest victim of Personal Services Income provisions…poor Mary!

PSI applies when most of your income is derived from your personal effort or skill, such as an actor’s agent, who only has one really important client. Or perhaps someone who (like Mary) consults for one company exclusively and has no other income.

More than 80% of her income is coming from one source, and this triggers the PSI rules meaning she can no longer claim rent, mortgage interest, land tax, payments to associates for support work, or expenses for more than one vehicle.

Worse yet, even if you have a company structure, PSI says all your income has to be attributed back to you, and declared on your personal tax return. It completely negates all the advantages of having a company in the first place.

If she had 21% of her income from another source, all these tax deductions would be available to her. With only one source she might lose them all.

Wait, You Said Might…

True, there is a test you can use that may exclude you from the PSI provisions. It’s subject to interpretation so you’ll need to consult an expert, but if you can answer “Yes to these three questions you may be excluded:

  1. Will your business only be paid when the work has been completed, having produced the results described in the contract?
  2. Will your business provide the tools and equipment to do the required work?
  3. Are you responsible for correcting defects in the work produced, or, is your company liable for the costs of such corrections?

If you can rally a “Yes” for each of these questions, you may get all your deductions back, and that’s only fair.

So What’s My Business Plan?

Set your fees carefully – be realistic and not cutthroat. Others have higher fees because they build-in the slow periods so there is money for expenses. Put money aside regularly because there will be slow periods. And charge for your services – even to consult on consulting – if it’s a big job. No one should expect you to work for free.

Ideally you’ll have six months income or more on tap, and if you don’t need it, invest it after you reward yourself with a cruise or car or some luxury item. If you don’t reward yourself occasionally you might begin to lose interest in your work.

SC&C Always Look for WorkKeep looking for work (unlike our friend Dick). You need a Marketing Plan which can include personalized written letters to prospects (very successful because they’re so uncommon), ebrochures, elists, newsletters, MailChimp, or other types of newsletter-sending mechanisms. Use everything at your disposal to keep your name out there and to keep yourself apprised of what’s happening in your field. Also, stay on top of your LinkedIn profile and connections – there are very few better ways to network.

When you do get a job, get everything in writing. It will save you heartache later on. Seriously – don’t be like Dick. Make sure you have Trigger dates for contract closeout including Substantial Completion, Physical Completion, and Final Acceptance.

Remember to protect your interests, too. The last thing you need is tax slips from every single job that you have to manipulate and manage. Here’s some vital advice, that is often overlooked, from a wikiHow article on creating your consulting contract:

“Consultant’s relationship with Client will be that of an independent contractor, and nothing in this Agreement is intended to, or should be construed to, create a partnership, agency, joint venture or employment relationship. No part of Consultants compensation will be subject to withholding by Client for the payment of any social security, federal, state or any other employee payroll taxes.”

You can manage your finances on your own. You’re smart enough to put money aside for year-end taxes (aren’t you?). Chasing down receipts isn’t what you signed up for.

Project your cashflow. Some people pay fast; some pay slowly; some run off and don’t pay at all. Ask for consulting money upfront – 25% to 50% is perfectly acceptable. For longer projects tie cash payments to milestones – there’s no reason to wait until the end to get paid.

If you have a drop-dead date (the point at which you go back to work for someone else), provided you’re not making enough money to survive, consider extending it by supplementing your income with another job. You might be amazed with how many quite successful consultants made it through tough times by turning to office temp work, office cleaning, bookstore clerks, factory line workers, or whatever you can imagine or do. One fellow I knew worked at a cemetery, cutting grass, planting flowers, and digging graves with a miniature backhoe.

There is absolutely no reason you can’t do this. Now get out there and make it work!