When hiring workers to help you with your small business, you may have to choose between hiring workers classified as employees and workers classified as independent contractors. This decision has a number of ramifications concerning tax liability, employer-worker relations and legal liability. Understanding the difference between employees and independent contractors, and the pros and cons of each classification is key to making the right call on this decision.
Independent contractors are workers who perform work for your business, but are not employed by your business. They may be self-employed or may be employees of another company. Employees are workers whose services are rendered exclusively to your business and who have certain employment rights under the law. The line between employees and independent contractors can be blurred at times. In general, however:
- Are given certain rights under labor laws concerning minimum wage, holiday and overtime pay, termination and working conditons.
- Covered by workers’ compensation paid for by their employers.
- Have an exclusive employment relationship with their employer.
- Have income tax and FICA taxes withheld from their paychecks by employers.
- Have employer-provided health care benefits.
- Cannot claim deductions for expenses related to work such as travel or meals.
- Are considered self-employed and are not covered by many of the same labor laws that employees are.
- Are responsible for submitting their own income and FICA taxes.
- Must provide their own workers’ comp insurance.
- Typically work for a number of employers.
- Can deduct business expenses from their tax bill.
The Pros and Cons
For independent contractors, the chief benefit to employers is the flexibility of the workforce and the lack of standing, long-term commitments to the employee. Hiring independent contractors results in lower overhead, as you will spend less in expenses, payroll and benefits. You also won’t have to spend as much time on bureaucratic work related to employment, such as withholding income and social security taxes.
Not having to provide health benefits is another advantage of hiring independent contractors. Providing health benefits for employees can cost thousands of dollars per employee.
Because you’re hiring workers to work on a per job basis, rather than an hourly basis, you have the flexibility to meet the changing demands of your business, ramping up staffing during peak times and tapering off as business slows. This helps you control your labor costs considerably.
There are some disadvantages to hiring independent contractors, however. You have less control over when the work is performed and how it is performed. With excellent independent contractors, or contractors who have worked for you before and are familiar with your needs this poses little problems, but for new or B and C players, this can be very problematic.
Fluctuating prices are another disadvantage. Independent contractors may charge varying rates per job based on their estimate of the complexity or difficulty of the job or on market demand. In some cases, this can drive costs up considerably at times when that’s the last thing your business can handle. Labor costs for employees are more settled and predictable.
Contractual obligations can be another downside to independent contractors. Contractors can demand extra compensation for changing assignments and also work termination penalties or other terms into the contract that makes it more difficult to dismiss them than employees.
Also, if you make an error and classify a worker as an independent contractor when according to IRS standards they should be employees, you run the risk of substantial penalties.
For employees, the advantages rest chiefly in having a stable workforce with predictable costs.
By hiring and coaching up employees, you can instill a level of buy-in and dedication that you simply can’t expect of an independent contractor who shifts from employer to employer. This loyalty can translate to increased productivity and innovation from your employees.
Employees may be more willing to take on a variety of roles than independent contractors, whose duties are more narrowly defined in their contracts.
Also, the stability a dedicated work force provides can be advantageous as it makes it more easy for you to coordinate yoru projects with employees who all work for you than guiding a loose confederacy of independent players.
The disadvantages for employees lie chiefly in the costs involved in providing them with a regular salary and in more administrative headaches. When you hire employees, you must pay them a regular salary, comply with many labor regulations, make sure that you’re withholding the appropriate amount of tax and deal with various other issues.
Also, the time you spend managing employees takes away time when you can focus on the more creative and dynamic parts of your business.
When making the choice between independent contractors and employees, consider the pros and cons and consider the task you need done. For short-term projects or busy seasons, taking on a few independents may be the right move. For long-term or recurring needs, hiring full-time employees may be a more effective means of getting the job done.