Contractors VS Employees
Hiring a contractor or an employee is a huge step for your business. But which option is right for you? We will break down the differences in contractor and employees so you can an informed decision on which makes the most sense for your business.
What is a contractor?
An independent, self-employed worker that operates independently of an employment contract. They can contract for one-time, short term, or long term services and projects. Although it can be long term, it is generally considered a temporary relationship. Usually contractors are permitted to do work for multiple companies at once, although they may have to abide by a non-compete or IP agreements in specific situations.
What is an employer?
An individual with a long term working relationship with a business. Employees can be paid either hourly or salaried. Although the amount of hours worked may vary, the hourly rate or salary is pre-determined.
The treatment of contractors and employees differ, it is important to understand how each with impact your business.
Payment and Payroll Taxes
Contractors are paid either a flat rate fee or by the hour. They can be paid in a variety of ways including check, cash, ACH or electronic networks such as PayPal, but most notably, no taxes are deducted from the payment. The business contracting the work will not pay any taxes, and the contractor is responsible for remitting SE taxes (self employment taxes) on behalf of their business. If a business pays a contractor more than $600 in a year, they will usually need to issue the contractor a 1099 for tax purposes (Check out this blog post on 1099s for further detail).
Employees are paid on a regular schedule and provided a W2 at the end of the year for their individual tax purposes. Payroll taxes for both the employer and the employee are deducted each paycheck and remitted to the federal and state government.
Benefits & Expense Reimbursements
Contractors do not receive any benefits and are normally responsible for any expenses they incur while on the job.
Employees receive all benefits that are offered by the company such as PTO, health insurance, disability and 401K plans. However; part time employees may not be eligible for benefits. Employees generally get reimbursed for appropriate expenses such as travel or meals that they are permitted to expense on a personal card for business purposes.
Training
Contractors receive little to know training. They are generally deemed technically competent in order to be a contractor. They may have to complete ethics or policy training to comply with company or government requirements.
Employees normally incur extensive training for the job. In addition to any technical training they likely need to complete training to comply with company and government requirements such as ethics and sexual harassment training.
So it seems easier and financially beneficial for a company to hire a contractor instead of an employee? What are some reasons why a company may choose to hire someone as an employee.
1. Employee Commitment
Employees may be more invested in the company and more likely to stay with the firm long term in comparison to a contractor. This is for a variety of reasons including culture, benefits, consistent income, vesting equity and internal growth potential. While an employee is hired at will and normally is free to quit whenever, the turnover is likely lower than a contractor. So if a company is concerned about staffing and turnover, hiring employees may be a good solution.
2. The IRS Rules Demand It
The IRS has strict guidelines on classifying individuals as contractors. The IRS is concerned about companies hiring individuals as contractors to 1) avoid paying in payroll tax and 2) to avoid providing benefits to individuals they are otherwise treating as employees.
The IRS looks mainly at 3 areas to determine if an individual can be treated as a contractor (See full IRS guidelines here). If you are ever concerned or confused, it is always best to consult with an employment attorney for guidance.
1. Behavioral Control: A worker is an employee when the business has the right to direct and control the work performed by the worker, even if that right is not exercised.
- Degree and type of instruction
- Evaluation systems
- Training
2. Financial Control: Does the business have a right to direct or control the financial and business aspects of the worker's job?
- Investment in supplies or equipment for individual
- Method of payment
- Expense reimbursement
3. Type of Relationship: The type of relationship depends upon how the worker and business perceive their interaction with one another.
- Contracts should clearly depict contractor or employee
- Benefits
- Length of relationship
- Services provided
So what does this mean for you hiring for your business? Each situation is different, but here are a few common scenarios that you may be able to apply to your business:
If you are hiring for a service outside your core business.
If you own a coffee shop and are looking to hire a social media manager for the the business instagram page, likely it makes sense to hire them as a contractor. Social media is not part of your core business, so unless you are a really large company (like Starbucks), you probably don’t need them full time, nor are they taking any of your day to day functions.
If you are looking for a seasonal or short term worker.
If you are an accountant who does taxes looking to hire extra help for tax season, it likely makes sense to hire a contractor. In this case, they would likely serve your company for a short, defined period of time (January – April) and then the relationship would terminate.
If you are looking for someone to replace your administrative roles
If you are a business coach looking for someone to assist you with admin tasks such as scheduling, you could hire a VA as a contractor.
If you are looking for someone to take some of your core business responsibilities off your plate.
If you are an attorney looking to hire a paralegal to assist you with legal research all year around on a regular schedule, it likely makes sense to hire this individual as an employee.
Both contractors and employees serve as crucial elements in business growth. Remember, even if you can do it yourself, it does not mean you should. Time is limited, and delegating time sucking tasks allows you to really tap into the growth potential of your business.