Small Business Bootcamp: Independent Contractor or Employee?

*Be sure to check out the other articles in this series Getting Back Into the Hiring Game & More Tips for Successful Hiring

Now that you have your hiring methods down, let’s go over a few things to keep in mind as you plan to increase staff and manage new employees. One major hurdle for small business hiring is determining whether your most recent staff addition should be classified as a contractor or an employee. Score.org (a nonprofit association dedicated to helping small businesses get off the ground, grow and achieve their goals) can help you figure out the difference.

When you need to bring in more help, the first thing to figure out is whether it’s best to hire an employee or an independent contractor. It’s best to start by understanding the differences between these two types of workers. 

Employee

Someone who performs services or labor for you on an ongoing basis, and you control what will be done and how. Employees stay on past the completion of each project. They tend to work at your businesses location, using equipment and tools that you supply. 

Contractor

Someone who performs services or labor for you, but is responsible only for the results, not how the project will be executed. A contractor’s work is usually done at the completion of each project— there are no ongoing responsibilities. Often they charge more, use their own equipment, set their own schedule and take care of their own business expenses. 

It’s a good rule of thumb to base hiring decisions not only on the type of working relationship you want to have, but also your tax responsibilities. 

Why it’s Different

Since contractors are self-employed, an employer is more like the contractor’s client than their supervisor. That means the contractor is responsible for paying taxes on their earnings. Independent contractors also don’t get a lot of the same benefits as employees: they’re not eligible for unemployment benefits, worker’s compensation, and social security. Plus, they don’t get offered sick leave, vacation, health insurance, and any other benefits an employer might offer to attract an employee. The contractor shoulders all of these costs since they’re treated like a self-employed business. 

All of this is fine as long as the independent contractor gets to be their own boss as it’s intended. Problems can arise when employers want the best of both worlds—they hire their workers as independent contractors, but treat them like employees, dictating when and how the work is done. Employers avoid paying payroll taxes and providing benefits, but in essence they have an employee who they can manage directly. 

What Happens if You Get it Wrong

Say one of your salespeople has his own office and works on commission. You have a second salesperson who works remotely and doesn’t receive benefits. You decided to hire them as independent contractors, but based on your working relationship, the IRS or another government agency might classify them as employees. If you misclassify employees as independent contractors, you’ll be on the hook for back payroll taxes, plus fines. 

To prevent that from happening, make sure everyone is clear on the nature of the working relationship. Choose the designation carefully based on the above guidelines, and create an employment agreement or an independent contractor agreement to document it. Then remain consistent with the classification. For example, if you treat workers like contractors in practice (and don’t pay payroll taxes) and then claim a tax deduction for having employees, a tax audit notice is a lot more likely to come your way. Workers can also make a complaint to the IRS if they feel they’ve been misclassified. 

Keep in mind that someone who starts as an independent contractor can assume responsibilities that are more and more like an employee over time. If you have a long-standing relationship with a contractor, consider bringing them on board officially to avoid misclassifying them. 

Creating and growing a successful business often means bringing on new additions to the team in order to better foster growth and increase productivity. Being compliant is a major factor is this development, as one wrong move could mean a lawsuit and/or the end of your business. Stay organized, do your research and seek a little help along the way. Happy hiring!

Traci Kingery, PHR is an HR Professional and freelance writer based in the Midwest, specializing in immigration and talent management. When she’s not improving unemployment, she keeps busy with her husband and four children.

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