Overview

As small business owners, entrepreneurs, and creatives, we need help managing our businesses and brands as we grow! At a certain point, it just isn’t possible to get all the work done by yourself. And, when hiring help, one of the biggest questions you'll face is:

Should I hire individuals as independent contractors or employees?

You can hire independent contractors and employees to do the same or similar work for your business, but there are important legal differences between the two. A worker’s classification as either an independent contractor or an employee affects everything from taxes and payroll obligations to benefits, insurance requirements, and compliance with state and federal laws.

Generally speaking, an independent contractor is someone who runs their own business provides services to multiple clients. An employee, on the other hand, is someone who is hired by your business and works under your direction and control as their employer.

Let's walk through the key differences between the two and then evaluate which option may be the best fit for you and your business!

The Differences

Employment Law

First and foremost, employees and contractors are treated differently under employment laws. Employees are generally covered by a number of federal and state labor laws, including wage and hour requirements, anti-discrimination protections, unemployment benefits, and workers’ compensation coverage. Independent contractors are typically not covered by these laws because they are considered self-employed business owners.

Thus, as a business owner, if you hire employees, you may be responsible for things like workers’ compensation insurance, unemployment insurance contributions, and compliance with various state and federal employment regulations.

Reporting Requirements

Second, business owners have different reporting requirements depending on worker classification.

For employees, employers must generally report wages paid during the year to the employee on a Form W-2 and withhold applicable payroll taxes.

For independent contractors, businesses generally issue a Form 1099-NEC when they pay $600 or more during a calendar year for services performed.

Payment Structure

Third, payment structures often differ between employees and contractors.

Employees are typically paid on a regular payroll schedule and receive either an hourly wage or salary.

Independent contractors generally set their own rates and submit invoices to their clients (the business owners) for completed services. Thus, business owners pay them after receiving an invoice. Business owners have more flexibility in structuring contractor payments, whether that's in a lump sum amount, or for hourly, daily, or weekly amounts that ends or start on specific dates.

Payroll Taxes & Unemployment Insurance

Fourth, business owners have additional obligations for employees.

Employers must generally withhold federal income taxes, Social Security taxes, Medicare taxes, and any applicable state taxes from employee paychecks. Employers are also responsible for paying the employer portion of certain payroll taxes and contributing to unemployment insurance programs.

Businesses typically do not withhold taxes for independent contractors. Instead, contractors are responsible for paying their own income taxes and self-employment taxes.

Tax Documents

Finally, the tax document requirements vary between the two.

Employees typically complete a Form W-4 so employers can properly calculate tax withholdings. This form includes information like the employee’s name, address, social security number, and tax filing status.

Independent contractors typically provide information like their name, address, taxpayer identification number, and more on a Form W-9. 

Benefits of Hiring Independent Contractors Instead of Employees When You’re Starting Out

Hiring independent contractors can be a great way to get help for your business without the long-term commitment, liability, and risk of taking on an employee (not to mention the other administrative responsibilities that often come with hiring employees!). I always like to recommend that entrepreneurs and small business owners first seek help from independent contractors.

For many entrepreneurs, especially in the early stages of growth, contractors provide flexibility. You can bring in specialized expertise and help when and where you need it without having to commit to hiring someone with a set amount of hours.

However, it is critical that the contractor relationship is structured properly! One of the most common mistakes small business owners make is treating a contractor like an employee.

Generally, contractors should have control over how they perform their work, when they complete projects, what tools they use, and whether they can work with other clients. While you can set project expectations, deliverables, and deadlines, the contractor must retain meaningful independence in how they accomplish the work for them to be considered an independent contractor.

“AHHH! I don’t know what type of person I hired! Help!”

Worker classification has become a major focus for both the IRS as well as many state labor agencies in recent years. Misclassifying employees as independent contractors can result in things like penalties, back taxes, and other legal consequences. 

In order to determine whether someone you hired is truly an employee or an independent contractor, you should weigh different factors such as:

• • Does your business control or have the right to control what work is performed and how it is performed?
    
    Does your business control important aspects of the relationship, such as payment methods, expense reimbursement, or providing equipment and tools? 
    
    Does the worker operate an independent business, offering similar services to multiple clients? 

• Is there a written contract that clearly outlines the relationship?
  
  Does the worker receive employee-type benefits, such as paid time off, health insurance, or retirement benefits? 

• Is the relationship expected to continue indefinitely, rather than being tied to a specific project or scope of work?
  
  Is the worker performing a core function of your business?

No single factor determines worker status. Instead, government agencies look at the overall relationship and the level of independence the worker truly has. 

If you are still unsure whether someone should be classified as an employee or an independent contractor, the best course of action is to seek legal guidance before moving forward. Proper classification from the start can help you avoid costly compliance issues later! You can always contact me with the specifics and I am happy to help you sort it out or point you in the right direction!

FINAL THOUGHTS

For many growing businesses and small business owners, independent contractors can be an excellent solution when you need flexible support and specialized expertise. As your business grows and your need for consistent, ongoing assistance increases, you may consider bringing on employees as a better long-term option.

The key is ensuring that whichever route you choose, the relationship is properly documented and legally compliant from the start!

Don't forget to check out TLP's Independent Contractor Agreement OR Employment Bundle!