Should You Hire Contractors or Employees for Your Small Business?

Independent Contractors vs. Employees

Getting help from independent contractors or hiring regular employees is an important decision for a small business owner, as each option carries distinct sets of pros and cons.

Independent Contractors

The greatest advantage of hiring contractors to pitch in is that they run their own businesses. There is no hassle with benefits, tax withholding, overtime or pretty much any obligation beyond paying the invoice for their services. A company with great fluctuations in workload can get help for a few weeks when needed. When things calm down, the small business pays the contractors’ invoice and the contractor goes on his merry way, whereas regular employees would stand largely idle collecting their regular paychecks. Contractors also provide their own tools, their own training and have their own liability insurance if they make mistakes.

However, those contractors are independent, so they have other clients and may turn down a business owner in his hour of need. Also, business owners should expect the hourly cost of working with contractors to be considerably higher than working with employees. Since the contractors are in business for themselves, they have to pay their own company and personal taxes, buy their own tools, pay for their own vehicles and so on, plus they must maintain some padding for hard times and eke out a sliver of profit to make the hassle worthwhile compared to the convenience of being regular employees.

Employees

Hiring regular, full-time employees gives the advantage of dependability and control. Employees have to follow directions on how to go about the job, what to say and how to act. Since employees work exclusively for the company, staffing is certain and the production level remains predictable. The employees may also be more motivated, since they have the chance for career advancement and bonuses. A positive team spirit can also make a big difference in productivity. Employees make it possible to delegate tasks and decrease the typical small business situation of wearing a large number of hats every day.

The downside is that each employee requires a significant amount of administration and reporting to various government agencies. There are also labor laws and regulations that apply, potentially opening up the company to lawsuits. Workers’ compensation, health insurance, retirement plans and so on cost money and take time to administrate. There is greater liability towards customers, as an employee more directly represents the company if something goes awry. It can also be difficult to lay off faithful employees in lean times, especially in a small business, where it’s easy to develop personal relationships.

Conclusion

Hiring contractors is often a good idea during the startup phase of a new business, when the workload fluctuates heavily and the owner needs a helping hand to cover the peaks. However, a business with a more predictable workload from the start may benefit from hiring regular, full-time employees, since they are cheaper and more dependable.

Beware the IRS

The ease of administration and lack of liability sometimes make small business owners wish to hire contractors for extended periods on an exclusive basis. This can be dangerous, as the Internal Revenue Service (IRS) may reclassify the contractor as a de facto employee if certain criteria are not met. The business owner is suddenly liable for a significant retroactive tax burden and faces stiff penalties for failing to report the employees properly.

Potential risk for such reclassification exists if any of the following applies:

• The contractor works exclusively for the small business.
• The business owner sets the hours rather than the contractor.
• The contractor uses the business’s tools rather than his own.
• The contractor supervises any regular employees.

Contact TBM Payroll for more information on Payroll Risk Management.

This article was originally published on Investopedia.