Employee or Independent Contractor - Pros and Cons

 Employees vs. Independent Contractors

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Marketing >> Employment & Employers >> Employees vs. independent contractors


Employee or Independent Contractor 

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 another task.

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 employees.  

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 available.  

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 Contractors

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 unemployment.

Cons of Hiring Independent Contractors

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 exceptions.  

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 fly. 

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 Withholding."

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 well.  

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.

Marketing >> Employment & Employers >> Employees vs. independent contractors


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