How to Decide Whether to Hire an Employee or a Contractor

When hiring for your business you should carefully consider whether you need an employee or independent contractor because the differences are really important.

If you hire an employee you will have more control over their work and performance, but you’ll pay more to the government and have more administrative work. If you hire a contractor, you lose some control but it is often cheaper and much easier.

We’ll dive into the various considerations below. But first, you might consider checking out our Contract Shop for templates that might help you:

Work Performance Considerations

  • Employees: When you hire an employee, you have a lot of control over both their work product and also how, when, and where they work. However, you are also expected to provide them with office space, equipment, and other things that increase your operating expenses.
  • Contractors: When you hire a contractor, you have control over their final work product, but you give up a lot of control over how, when, and where the contractor works. With contractor’s, however, you are not expected to provide equipment or office space.

Tax Considerations

  • Employees: When you hire an employee, you must withhold (and remit to local, state, and federal taxing authorities) a portion of the employee’s salary for income taxes and their half of their employment taxes (medicare and social security). Further, you are required to pay the other half of their employment taxes and you may be required to pay into workers’ compensation funds and pay additional unemployment taxes. As a result, you should anticipate paying 10%-12% more in taxes and similar expenses when hiring employees as compared to contractors. Additionally, you should consider your administrative fees like payroll expenses. (We use Gusto (that’s our referral link) and find their platform and pricing perfect for our business.)
  • Contractors: Among the best elements of hiring contractors is that they are responsible for withholding and paying their own income taxes and also the entire amount of their employment taxes (medicare and social security). You also can avoid workers’ compensation and unemployment taxes when you hire contractors. Clearly, this all makes paying contractors much easier than paying employees. However, if you pay a contractor more than $600 in one year, you need to provide both them and the IRS with an IRS Form 1099. (To help you do this, always require your contractor submit a Form W9 to you before you pay them.)

Intellectual Property

  • Employees: The Copyright Act states that copyright in works created by an employee within their scope of employment will be owned by the employer. This makes it easy for you when hiring employees to create things.
  • Contractors: However, when you hire a contractor, it is critical that you get a copyright transfer in writing from the contractor. If you don’t, odds are the contractor will own all copyright in their work product because, without a writing, their works won’t constitute “works made for hire.”

Termination Rights

  • Employees: In most situations, you’re employees will be deemed “at will” employees. This means you (and them) can terminate the employment relationship at any time, for any reason (but not for discriminatory reasons).
  • Contractors: Your relationship with your contractors, however, is much different. For the most part, the termination rights of both you and them will be whatever your contractor agreement requires.

What the IRS Says

You should always be careful when classifying workers as contractors or employees because, regardless what you say, the IRS will use their own guidelines when deciding how you should treat your workers. Here’s a basic summary of how they classify workers:

  • A worker is likely an employee if (a) you control when, where, and how, the worker performs services; (b) you provide the worker’s tools and equipment; (c) you control how and when the worker is paid; (d) you give them employee-style benefits; and/or (e) the relationship doesn’t have an end date.
  • A worker is likely an independent contractor if (a) the worker controls when, where, and how, he or she performs services; (b) the worker provides his or her own tools and equipment; (c) payment terms are controlled by the worker; (d) the worker doesn’t receive employee-style benefits; and/or (e) the worker works on a project basis.

What You Should Do

Obviously this decision can have major consequences, both good and bad, for your company.

One good practice is to engage new workers as contractors without employment benefits for some period of time, perhaps three to six months. Test them out and if they are a good fit, then offer them employment with employment benefits.

You should also consider talking with an attorney to avoid making a wrong classification. If you do make a mistake, you may end up owing the government a lot of money.

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Image: Adobe/kubko

*This article is very general in nature and does not constitute legal advice.