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Hiring Independent Contractors vs. Employees

Independent contractors and employees often work at the same company, even doing similar work. There are important legal differences between the two. The main difference between an employee and an independent contractor is the employer's degree of control over the worker.

An employer controls how, where, and when employees perform their jobs. The employer hires a contractor to complete a task and only controls the result.

Employers trying to save money sometimes classify employees as independent contractors. Misclassification can have severe consequences for small business owners. Employment status affects benefits, tax credits, employer liability, etc. Employers must know the difference between contractors and employees before hiring employees.

Employee vs. Contractor: Which One Do You Need?

When business owners need a new employee, they must weigh their options. You may look around at everything that needs to get done and decide you need another employee right now. Then, you crunch the numbers and realize your business won't support another full-time employee. You may need specialized tasks done periodically, but none of your workers has the skills required.

Choosing which type of worker is best for your business means weighing the long-term and short-term considerations of your needs and those of the employee.

Full-Time Employee

Hiring a full-time employee means taking on a new worker. You must follow the Fair Labor Standards Act (FLSA) regulations. If you offer employee benefits, you must provide them to this new worker. New employees are overhead, so your profit margin must be high enough to cover this cost.

Some signs you may want a full-time employee:

  • You don't have enough workers. Things aren't getting done, or customers must wait for help.
  • You regularly depend on freelancers or part-time help. Part-time workers may cost less but can't give your business the attention it deserves.
  • You are spending time on low-level chores. As the owner, you must spend time on your own business. You shouldn't be doing tasks your employees should do.

Part-Time Employee

Small businesses often use several part-time workers when the schedule does not need the same number of full-time employees. Business owners may think part-time workers cost businesses less than full-time workers since a part-time employee works fewer hours. Recent changes to state and federal laws have eliminated many differences between "full-time" and "part-time" workers.

  • Under the Affordable Care Act (ACA), employers must provide health insurance to all "similarly situated" employees who work more than 30 hours per week.
  • Some states, such as California, mandate paid vacation time, sick leave, and minimum wages for all workers, regardless of hourly status.
  • Businesses with over 50 employees of any classification must obey the Family and Medical Leave Act (FMLA). All eligible workers may take up to 12 weeks of unpaid leave every 12 months.

With these caveats, part-time employees are helpful for small business owners who need seasonal or weekend workers.

Independent Contractors

The 2020 pandemic was a wake-up call for small businesses and niche specialists. Small companies need people who can work with minimal oversight on a single project. They need someone with special training or skills their employees don't have. Contract workers may work for a specified period or on a one-time project. They do not have an employer-employee relationship with the business owner.

The Internal Revenue Service (IRS) has guidelines for separating "employees" and "contractors." Employers must know the difference because misclassification may result in fines and penalties. The IRS frowns on employers who intentionally misclassify employees as "independent contractors" to avoid payroll taxes.

Your business could benefit from an independent contractor if you need:

  • A worker for a short term or a project outside the scope of regular work.
  • Equipment your business does not have and which you won't need after this project is over. Contract workers provide their own tools and equipment when necessary.
  • You can afford a fixed amount for a job but not the extra time or money involved with hiring a worker. Contractors manage their own state and federal income tax, health care, and other paperwork.

Whether someone is an employee or contractor hinges on how much control the employer exercises over the worker and the work product. Having an independent contractor agreement does not mean a worker is an "independent contractor." A contractor may get a lump sum or an hourly rate. They may work from home or come to the job site. They might work regular hours or come in when they choose. The most important factors are the nature of the employment relationship and the degree of freedom the contractor has.

The chart below outlines key differences between employees and independent contractors.

Employees

Independent contractors

Typically work for just one employer

Often provide consulting services to more than one company or client

Work hours established by the employer

Set their own hours

Usually work at the employer's place of business.

Often work out of their own home or office

May get employment benefits (i.e. vacation, health insurance)

Don't get employment benefits from the company or client

Work under the direction of the employer

Work independently

Complete tasks according to the employer's request/instructions

Have control over how to do the assigned tasks without the employer's input

Typically don't incur costs in performing their work duties

Incur the costs of performing the job

Have a general education and experience background and get special training from the employer

Have specialized skills and come to the relationship with a specific education and experience background

Get net salary after income tax — Social Security and Medicare tax get withheld (FICA).

Not subject to tax or FICA withholding but pays a self-employment tax

Eligible for unemployment insurance benefits after a lay-off or termination.

Ineligible for unemployment compensation benefits.

Eligible for unemployment insurance benefits after a layoff or termination

Ineligible for workers' compensation benefits.

Can be terminated by the employer only for good cause and with notice (unless the employment is "at will")

Can get fired by the employer for any reason and at any time (unless the contract is for a specified term)

Covered by state and federal wage and hour laws, including minimum wage and overtime rules

Paid according to the contract terms and not eligible for overtime pay

Protected by workplace safety and employment anti-discrimination laws

Usually not protected by employment anti-discrimination and workplace safety laws

May join or form a union

Can't join or form a union

Getting Legal Help

Misclassifying an employee as an independent contractor can lead to many problems, including problems with the IRS. Contact a local employment lawyer for guidance if you want help determining if you're hiring an independent contractor.

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