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People in Israel typically consider the freelance (contractor, self-employed) issue in one of these situations:
- They are offered a job as a freelancer, and want to know what to do to be able to accept such payments
- They are offered a job as a freelancer, and need to understand how the offer compares to the compensation of something they understand better: a traditional employee
- They are offered the option by an organization to work as a freelancer or as an employee, and must decide which is best of them (this is relatively rare)
I will start (and end!) with a disclaimer:
This issue is possible to discuss generally, however it is dangerous to think that you have a full understanding of the issues without consultations with the relevant financial (accountant, investment, insurance) professionals.
Freelancer - someone that provides a service to a company (works), presents a bill, and is subsequently paid by the company. The freelancer is responsible for paying taxes, social security, health… themselves from the total amount that they receive, as well as contributing to savings/insurance/disability/pension plans if desired. In order to be eligible to operate as a contractor, a person must register with the relevant government organizations: VAT, Mas Hachnasa (tax) and Bituach Leumi (social security).
Employee - provides service to the company (works), but their compensation comes without requiring a bill to be presented; the employer makes standard deductions (tax, social security and health) before transmitting compensation (neto) and has specific legal obligations to the employee (pension, vacation, sick leave, severance pay [pitzuim]).
Before discussing the issues of freelancer’s compensation, it is important to understand the there is a solution available for those that are interested in accepting a contractor position, but do not want to invest the time, and effort to go through the process of registering as self-employed with the government authorities. That is, to enroll with a company that serves as your proxy for the transaction, acting to the actual employer as a contractor and presenting the relevant bills, and serving as the individual’s employer, meaning that the individual is still an employee (of the proxy company rather than the real employer) for legal and administrative purposes. A company that I am familiar with charges a one-time set-up fee of 300 NIS, and then 7% of the amount transmitted by the actual employer.
Back to the subject at hand, the gross amount paid to an employee before taxes (bruto) and the gross amount paid to a contractor can not be understood and compared as equivalent. From the perspective of certain deductions, such as tax and health, they are financially identical - the only difference being that in the case of an employee the company makes these deductions before transferring the money, and in the case of the contractor the money is transferred without deductions and the freelancer must handle this themselves. Still, the after-tax (netto) amount of money is the same.
However, companies are obligated by law to offer to their employees vacation (minimum 10 days/year), sick leave (minimum 18 days/year), pension (2.5% minimum in 2010), and severance pay (equal to 8.3%/month), things with a monetary value; these are not generally provided to a contractor. Social security is a kind of hybrid in that employers deduct a portion of the gross/bruto pay as well as make a required contribution of 6% for their employees; contractors must make this payment themselves and do not get this extra 6%. In addition, some businesses offer additional benefits, such as a variety of savings/pension plans in addition to the obligatory (and minimal) pension plan; again these are typically not provided to contractors.
So, when you are considering an offer as a freelancer, these points are relevant:
In terms of standard deductions (health, tax), consider the contractor gross amount to be financially identical to the bruto (before tax) amount of an employer
To make the contractor amount comparable with the bruto employee total, about 25% needs to be added, which accounts for the social security, minimum vacation, sick leave, and pension obligations of a company towards employees, plus severance pay – a contractor does not receive this from the employer. You can think of the situation like this: if a freelancer wants the same benefits as an employee of the company at the same pay structure, he/she will have to pay about 25% of the received compensation. Speak to an accountant to relate this to your personal situation.
For hi-tech companies and professional roles, it is not unusual to be offered employee savings/pension plans in addition to the relatively low level mandatory pension plan. The standard package can come to an additional company contribution of 12.5% or more. For such an opportunity, generally a contractor should add in the range of 35+% to the gross salary of an employee to arrive at the equivalent compensation. The 35% is derived from the lack of savings, pension, severance company contributions together with the lack of vacation/sick leave/disability insurance. It is sometimes possible to negotiate up if you can make the argument that as a contractor, the company doesn't have to pay for a room for you, PC... if this really is the case. Again, keep in mind that this is a rough estimate, and you should consult with an accountant to understand as this relates to your specific case.
Note: A self-employed (contractor, freelance) US citizen in Israel has a kind of double taxation, being required to pay the Israeli bituach leumi (social security, like all Israelis), and also having to pay 14.1% to US social security. Obviously, this social security issue makes the freelance option less attractive to US citizens. While this point is not attributable to the employer and thus may not be useful to you in terms of a negotiation, it is a real cost and therefore a factor in your decision.
Another difference between working as an employee and as a contractor relates to unemployment benefits. If an employee is laid off and the employer writes them a letter, they are eligible to receive unemployment benefits (assuming specific conditions are met); there is no such provision for a contractor. Please note that for people going the proxy company route, unemployment benefits are also not available to you.
In order to be complete, there are other costs associated with working as a contractors/freelance that don’t exist for a regular employee. First, there are one-time costs to complete the paperwork so that you can operate legally in Israel as a freelancer.
There is no charge by the government organizations to submit/process these forms; if you decide to use an accountant for assistance with the forms it generally costs 1,000-1,500 NIS. This process generally takes less than a week.
Also, certain professions and businesses may require certificates and/or licensing from other governmental agencies in order to work as a contractor. In addition, you must pay an accountant to file the relevant tax forms. There are potential benefits to the freelance mode of operation in that you can deduct certain expenses, such as car, utilities…
This article is in no way meant to substitute for consulting with a qualified financial professional, including an accountant, investment advisor and/or insurance agent, in order to fully understand the options specific to your situation.
Hopefully though, it does give a good initial overall picture of the details to consider and the questions to ask when going through the process.
Special thanks to Boaz Felsenstein and Don Shrensky for reviewing this article and making critical comments.
Boaz is an experienced recruiter specializing in the hi-tech sector, and he can be reached at: email@example.com.
Don is a US & Israeli CPA, and can be reached in Jerusalem at firstname.lastname@example.org
Contributed by Ron Machol - March 2010
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