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, the biggest dilemma you will 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. The status of someone who works in your business makes a difference in how you pay them and how they pay their own taxes. An independent contractor is essentially someone who runs their own business and freelances for other businesses. An employee is hired by you to work at the direction of you as their employer.
Now, let’s go through the nitty-gritty differences and then evaluate which option is the best for you and your business!
First and foremost, employees and contractors are different in regards to employment laws. Employees are covered by a number of federal and state labor laws, whereas contractors are not covered by any employment or labor laws. Thus, employers must pay into the worker’s compensation fund and employees are covered with benefits if they are injured on the job.
Second, small business owners have different reporting requirements for each status. For employees, employers must report all money paid to the employee during the tax year on a W-2. For contractors, employers must report payments of $600 or more in a calendar year on a Form 1099. (If you don’t know what a form 1099 is, go check out last week’s blog post here).
Value and Payment Schedules
Third, the value and payment schedules can vary between employees and contractors. For employees, business owners must establish a regular pay period, and employees earns either an hourly rate or a salary. For contractors, business owners pay them after receiving an invoice. Business owners have more flexibility in how they pay contractors (i.e. it can be in a lump sum amount, or for hourly, daily, or weekly amounts that ends or start on specific dates).
Unemployment Insurance & Withholdings
Fourth, business owners need to report state and federal unemployment insurance for employees, but business owners have no obligation to do so for contractors. An employer also must withhold payroll taxes from their employees on each paycheck and match certain amounts (Federal income tax, state income tax, Social Security tax, and Medicare tax).
Finally, the tax document requirements vary between the two. For employees, information regarding the employees, name, address, social security number, tax filing status, and number of exemptions on a W-4 must be provided to the employer. For contractors, information including name, address, taxpayer identification number, and certification about backup withholding on a W-9 must be provided.
Benefits of Hiring Independent Contractors Instead of Employees When You’re Starting Out
Independent contractors are a great way to get help for your business without the commitment, liability, and risk of taking on an employee. I would recommend that entrepreneurs first seek help from independent contractors. You business is likely to fluctuate as you start out, so you will not be stressed about having to pay an employee. Contractors will allow you to get help where and when you need it, without having to hire someone with a set amount of hours. However, you need to ensure that you aren’t controlling the contractors schedule and ability to say no. They must be truly “independent” for them to be considered an independent contractor. Thus, you can give them projects and deadlines, but must allow them space, time, and control to complete it as they see fit.
“AHHH! I don’t know what type of person I hired! Help!”
In order to determine whether a person you hired is an employee or independent contractor, you should weigh different factors to determine the relationship with the person:
- Does your business control or have the right to control what the worker does and how the worker does the job?
- Does your business control the business aspects of the worker’s job? These include arrangements like how the worker is paid, whether expenses are reimbursed, and who provides tools and supplies.
- Is there a written contract or employee benefits such as a pension plan, insurance, or vacation pay?
- Will the relationship continue and is the work a key aspect of the business?
If you answer yes to any of these questions, you likely have brought someone onto your team as an employee, and will need to pay them regularly, comply with labor laws, and pay/match payroll taxes. If you are still unsure, contact me with the specifics and I am happy to help you sort it out!