Employee or Independent
At some point in your business,
chances are that you are going to face the prospect of bringing on
additional help to get the job done, so that your company can
grow, and hopefully, so that you can take a vacation, a day off,
or sell the business some day.
It is at this point that you must
face the question that every business faces and that is whether
you are better off hiring employees or independent contractors.
This is an important decision and
one that is not to be taken lightly. Once you choose a
direction, changing course can become extremely complicated and
risky. Here is a guide that will help you in your decision
to go the employee route or hire independent contractors:
Pros of Hiring Employees
Improved workflow - When you are
dealing with an employee that you have an exclusive arrangement
with, you aren't dealing with any other company's schedule.
Your employees only work for you, they have a schedule, and you
know their availability.
Loyalty - Your employees don't
work for your competition and this means that you don't have to be
concerned as much about what your competition knows about your
business or your clients.
Wearing many hats - In small
companies, it is often important that employees can do a variety
of things. While they might have a primary duty, you can
have an employee who is otherwise unengaged at the moment, handle
Growth into management - As your
business grows, it will require additional management
services. Those who know your business best are often best
suited for this, and they are best suited to train other
Cons of Hiring Employees
Overhead - Employees cost you
more. Most employers provide some sort of employee benefits
and there are the tax implications and the time cost of managing
typical employer functions.
Higher direct labor costs -
Employees need to be paid, even if work is not
Transitioning your role - As you
employ new people, your role becomes less of a hands on operator
and more of a people manager.
Pros of Hiring Independent
Lower overhead - Hiring
freelancers/independent contractors means that your costs are
lower. If there's no work, you aren't paying. Your
employee expenses such as payroll, employers share of taxes, and
the cost of maintaining these records goes down. Less
overhead means lower financial stress on a new business.
No health benefits - As costs of
health insurance and parental leave increase, so do the extraneous
costs of hiring employees. According to the Mercer 2003
National Survey of Employer Sponsored Health Plans, the cost of
health care per employee in 2003 was over $6200 per year.
Flexibility - As you grow, you
may find that you have wide swings of ups and downs of available
work. Hiring an independent contractor generally means that
you are hiring fully trained people who are specialized. If
sales go down, you can easily adjust the number of contractors
without suffering the costs associated with layoffs, like
Cons of Hiring Independent
Market rate of services - Because
you hire independent contractors, you essentially pay for services
according to the rates they set. If market rates go up or a
given contractor has more work than they can handle, they may
adjust for this by increasing their rates. To get around
this, you might consider setting up a term contract where they
will guarantee you rates for a specific period of time.
Lost control - Contractors can
choose to work or not to work, and they have the ultimate control
over whether they will work for you in a given situation or for
one of your clients.
Misclassification - If you do not
abide by the IRS rules for what constitutes an employee, you may
find yourself subject to withholding taxes and significant
penalties. If you hire independent contractors, make sure
you follow the simple rules to the letter... no
Lost security - Your independent
contractor might also work for one of your competitors.
Though it would be unethical of them to discuss your business with
that competitor or vice versa, it still happens. There is no
guarantee of protecting your sensitive company information, so the
best advice is to work with independent contractors on a need to
know basis. Do not disclose information to any independent
that would potentially be damaging to your company.
Also be sure that you have a
standard form Non-Disclosure Agreement (NDA) for each.
Again, it does not guarantee anything, but a proper NDA does
impose penalties on the contractor if they let loose lips
Who is an Independent Contractor
(what rules apply)?
The IRS sets rules for who is an
employee and who is an independent contractor. There used to
be something known as the "20 Common Law Factors
Test". This no longer applies and has been replaced by
a 3-rule test. If you violate even one of these rules once,
your independent contractor might be considered an employee
and you can be penalized.
Independent Contractor Rules
1) How much control you have over
the worker. Though the job can be written in a way that
requires certain duties at certain times, and under certain
conditions, you have to be careful that this is part of the job or
your contract with the client. If you simply require the
person to do the job according to your schedule and under your
terms, they could be considered an employee. They could also
be considered an employee if they did not have the ability to turn
down jobs or if you prevent them from working for someone else.
2) Financial control - Dictates
how much control you have over a worker's pay, how it is
distributed, or the kind of expenses that you pay.
3) Relationship based on
agreements, benefits, and the kind of relationship between the
company and the worker. If you provide benefits to a worker
that are similar to those commonly found with employees, the
relationship could be termed that of an employer.
If you aren't sure if a worker
would be considered an employee or an independent contractor, you
can file Form SS-8, "Determination of Worker Status for
Purposes of Federal Employment Taxes and Income Tax
Meeting the IRS test is not the
only hurdle to determine independent contractor status. Fair
Labor Standards Act (FLSA) covers several criteria including if
the service requires special skills.
If you choose to hire independent
contractors, make sure that you are insured against their actions
and that they maintain their own liability insurance as
A common misconception among
small business owners is that hiring contractors means that you
are not responsible for their actions. Not true! A
contractor that works for you may be liable too, but it doesn't
get you off the hook, especially if the client doesn't understand
the legal difference between the relationship.