Your business is booming and it’s finally time to recruit additional help. As a small business owner, it can be a challenge to go about expanding your team. Should you seek to bring on an independent contractor or an employee? Here we highlight some of the differences between the two and why it matters.
Independent Contractors
An independent contractor is someone hired for a specific project or task. Contractors usually:
- Run a business of their own
- Sign a contract stating they are independent contractors
- Serve other customers or businesses
- Provide a service your business does not provide
- Set their own hours and schedule
- Have their own equipment and expenses regardless of the project
- Have their own training prior to employment
- Work project-by-project
- Invoice their clients
An example of an independent contractor is a landscaper who is hired by a graphic design firm to improve the front yard of their business. They do not provide any services relating to the firm’s direct products or services. This landscaper works with other businesses, invoices their clients, purchases their own equipment and sets their schedule. Furthermore, they are only employed by the business for a specific project. (Tax tip: If you opt to hire independent contractors, be sure to collect W-9 forms when they are paid — this prevents a headache when tax season comes around!)
Employees
An employee is someone hired to work indefinitely for a business on a regular basis. An employee can be part-time or full-time.
Employees usually:
- Work directly for a business
- Are exclusive to one business
- Are paid hourly or are salaried
- Receive training from the employer
- Have a work schedule set by their employer
- Provide services directly related to the business’s products or services
- Receive vacation day, sick days and benefits
- Use the business’s equipment
- Have reimbursed expenses
An example of an employee is a graphic designer hired by a graphic design firm. They come to work on a set schedule such as 8 am to 5 pm, Monday through Friday, and they are trained by a supervisor when they are hired. They get paid on a regular schedule, typically bi-weekly, and receive benefits like health insurance and vacation days. Their only job is at the graphic design firm, and they are hired to work for an indefinite period of time.
Why It Matters
As a general rule, contractors cost less for businesses to hire. The Federal Insurance Contributions Act (FICA) requires businesses to pay Social Security and Medicare taxes for each employee. For 2022, the FICA tax rate is 7.65% of the employee’s salary. Employees are also protected by state and federal labor laws, which means they are provided overtime and wrongful termination protection as well as severance if a business terminates them. Contractors are not afforded any of these protections.
As a business owner, it can be tempting to want to hire your workers as contractors to avoid these taxes and complications, but there are important distinctions between the two.
How to tell the difference
The IRS considers three main categories of evidence: behavioral control, financial control and relationship of the parties.
Concerning behavioral control, if a business controls how the work is done through instruction or training, the worker is likely an employee. Financial control addresses whether the employer or worker pays for necessary equipment, how the worker is paid and if the worker offers his or her services to the relevant market. Relationship of the parties identifies who is making scheduling decisions, whether the business is providing employee-type benefits and the permanency of the relationship.
Deciding between the classifications can be a fine line for employers to walk and can be a costly mistake if the IRS doesn’t agree with your determination.
The Bottom Line
Hiring independent contractors can save your business from managing healthcare benefits, vacation days and overtime. It also can save you money spent on taxes and equipment. However, your business does not have control over independent contractors. They are free to set their own hours and rates, work with other companies and will usually not work for one business indefinitely.
Hiring an employee allows your business to control their work schedule, train them, provide them the appropriate equipment and maintain a consistent relationship. However, employees are typically more expensive due to taxes and overtime, and they are more legally protected than contractors.
Whether you hire an independent contractor or an employee, keep in mind it’s important to get paperwork and forms like a W-4 or W-9 completed before your employee’s first day.
Need Professional Help?
At Gift CPAs, our team of experts is here to help you as you grow your business. Thanks to our relationship-based approach, we make sure we thoroughly understand your business needs, and will offer sound advice to help you plan and achieve your business goals.
If you’d like to meet with a professional and get personalized advice, contact Gift CPAs to learn more about our services. Make an appointment to meet virtually or at one of our five locations in Harrisburg, Mechanicsburg, Myerstown, Ephrata or Lancaster!
