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Small Business Hiring: Employee vs. Independent Contractor

October 5, 2016

If your business has grown to the point where you can no longer do everything yourself— congratulations! That’s a big milestone for entrepreneurs and it signifies that you’re making smart business decisions. Bringing on a new employee or contractor is a smart way to ease your workload, but it’s not something that should be entered into lightly and there are some important distinctions between the two classes of workers.   When choosing between the two, keep the following considerations in mind.

  1. Defining the relationship

Before you decide to take on  a contractor or employee,  think about the type of relationship you will have with the person you’re planning to bring on. The IRS has specific parameters around the definition of an employee versus an independent contractor. Here are some factors can help you decide whether your new hire will be a independent contractor or an employee.

  • Control over their work – According to the IRS, an independent  contractor has a certain degree of control over their work, and independence when doing that work. If the business does not have the right to direct and control the work, the worker is considered to be an independent contractor. This includes the type and degree of instruction given, training and evaluation systems. In other words, a contractor can be told what must be done, but not how it must be done. A company can measure the end result of a contractor’s productivity, but not the details of how the work is performed.
  • Training – Training is another indicator of the relationship. If the company provides training, particularly periodic or on-going training, the worker is likely an employee and not an independent contractor. An independent contractor could be trained on the company’s systems and procedures, but would not receive regular training for the purpose of advancing their position.
  •  Payment and Benefits – Some business considerations may also factor in to the definition of the relationship. If you determine how the person is paid, reimburse expenses and provide tools and supplies, the person would be considered an employee. Likewise, benefits such as vacation pay, life or disability insurance or a retirement plan are provided to employees, not to independent contractors.

  1. Determine your needs

Taking on your first full-time employee is a big commitment. If your business is seasonal, or if you think you may need someone only temporarily, an independent contractor may be a better fit, at least to start. You can always bring on an employee down the road.

Many companies hire someone part time if they don’t think they have enough work to support a full-time position. A part-time employee is typically paid by the hour and does not receive benefits, but you could provide them if you want to

  1. Understand Legal requirements

Hiring an employee means you have several obligations.

  • Worker’s compensation insurance. If you have employees you are required to carry worker’s compensation insurance, which covers your employee(s) if they are injured on the job. Each state has its own regulations around worker’s compensation insurance, so consult with your state’s Division of Labor or Worker’s Compensation agency to determine your requirements.
  • Unemployment insurance. Businesses pay a tax based on the number of employees they have and how much previous employees have collected. This money goes into a state pool that is used to pay workers who are involuntarily terminated from their jobs so they can pay their bills until they find a new job.
  • Tax withholding. You are required to withhold taxes from the amount you pay your employee(s), and you must send the money to the government on a regular basis. At the end of the year, you must issue a W-2 tax statement to the employee(s) showing how much you withheld. You are not required to withhold taxes from the compensation paid to an independent contractor. You issue a 1099 tax statement indicating the amount you paid, and the contract is responsible for filing and paying their own taxes.

Other considerations

Whether you have employees or independent contractors, business insurance can protect your business from damages or injury they cause, or from negligence stemming from their work. Some independent contractors may carry their own insurance as well, but it’s good to know that you are protected  if your company is sued.

If you hire an employee, you will probably pay less in wages, but more in benefits. Depending on the number of employees you have you may need to, or choose to, offer health insurance. You may choose to offer a retirement plan. You may not need to pay into these programs but there are often administrative costs.

Expect to spend more per hour for a contractor than you would for an employee, because the contractor will have no benefits, and because of the temporary nature of the contractor relationship.

Carefully considering whether to take on an independent contractor or a full-time employee will help you expand your business the right way.