Most small business owners struggle with making the decision on whether or not to hire independent contractors. Like everything else in the world, there are always pros and cons to every decision. Not having to worry about withholding taxes from employee wages or having to deal with payroll returns may sound enticing but there are a few things to consider before making the final verdict. Let’s start by discussing how the IRs differentiates independent contractors from employees.
There are two major classifications of workers. Independent Contractors and Employees. However, altogether there are 5 types of business relationships that can exist.
An independent contractor
An employee (common-law employee)
A statutory employee
A statutory nonemployee
A government worker
The IRS previously used a 20 Factor Test to determine a person’s classification. The IRS has since grouped those questions into three groups called Common Law Rules. Since there is no uniform definition of who are considered employees, a series of factors must be considered when making a determination. Please note that not one factor stands alone in making a determination and that factors that applied to one scenario may not apply to another. The key is looking at the overall relationship of the parties and if the work is integral to the success of the business. There are three Common Law Rules:
1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job? The general rule is this:
When working with contractors, you can specify the end product and a deadline for it. You can’t mandate things like where a contractor works or the hours they keep.
When working with employees, you have much more control over how, when, and where that work gets done.
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
How Should I Decide Who Should Do What?
Independent contractors can be a good solution if the work you need done is:
A short-term project (like a new product launch or seasonal assignments)
Specialized and transactional (you won’t need to coach the contractor through each step)
Outside your core business offering
Hiring employees can be a better option if the work is:
Long-term and ongoing
Central to what your business does
Dependent on others
Includes multiple projects. Employees can handle various tasks at the same time and you don’t have to get them up to speed before each and every undertaking. That, in itself, can make employees more cost (and time) effective in the long-run.
If you are relying on the same person to do the same task everyday, you may want to hire an employee to keep the flow consistent.
Advantages and Disadvantages of Hiring an Independent Contractor
Most workers prefer to be independent contractors. Most owners prefer to hire Independent contractors even though they get paid more than general employees because of how expensive hiring employees can get. Take a look at a few of the pros and cons below to help decide what will work best for your situation.
Cost Savings (employer provided benefits, required contributions)
Staffing Flexibility (can hire just for certain tasks)
Reduced Tax, Insurance and Legal Exposure
Great for project based or creative tasks
Less Control of over the how, when, and where or work
Finite Working Relationship
Depends on the Terms of the Contract
Quality of work may be uneven.
It will be harder to estimate costs as independent contractors set their own rates
Independ contractors are not covered by workers comp. so independent contractors can sue the company for any associated damages
The employer may not own copyrights or work created by the independent contractor.
Advantages and Disadvantages of Hiring an Employee
Tend to be more invested in your business
Longer return on upfront training and development investment
More predictable cost as you decide their pay
Employer Tax Obligations ( may cost more to hire)
Department of Labor (DOL)
Employer Minimum Wage / Overtime Obligations/ PTO
Employer Anti-Discrimination Coverage
Employees are protected from many laws whereas independent contractors are covered based on whatever contractual agreement you decided
Less flexibility to reduce or increase workers
More complicated hiring process (background checks/ drug tests)
What Does the IRS Say?
According to the Internal Revenue Service (IRS), a worker is an employee if
“You can control what will be done and how it will be done. This is so even when you give the employee freedom of action. What matters is that you have the right to control the details of how the services are performed.”
A worker is considered an independent contractor if
“The payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
Review the chart prepared by https://legalaidatwork.org/ to help further determine what is right for you.
Do you have questions on how to make your business more efficient financially? Book an online consultation here or call now at 404-449-1528! At Credence Tax Services LLC, we use strategic approaches to maximize all opportunities to save our client’s money!