Should You Hire an Employee or a Contractor? The Difference Is Vital

This post was adapted with permission from Chris Brown’s blog at Venture Legal.

When hiring for your business, carefully consider if you need an employee or an independent contractor because the differences are important. Here to give us some advice on this important topic is Chris Brown. He represents Kansas City small businesses, startups and freelancers through Venture Legal and is also working on Contract Canvas, a digital contract platform for creative professionals.

So, here are your options: If you hire an employee, you’ll have more control over their work and performance, but you’ll pay more to the government and have more administrative work. If you hire a contractor, you lose some control, but it’s often cheaper and much easier.

Take it away, Chris.

Weighing Work Performance

• Employees: When you hire an employee, you have a lot of control over both their work product and also how, when and where they work. But you’re also expected to provide office space, equipment and other things that can increase your operating expenses.

• Contractors: When you hire a contractor, you have control over their final work product, but you give up a lot of control over how, when and where the contractor works. Plus, you’re not expected to provide equipment or office space.

A Taxing Consideration

• Employees: When you hire an employee, you have to withhold (and remit to local, state and federal taxing authorities) a portion of the employee’s salary for income taxes and their half of their employment taxes (Medicare and Social Security). Further, you are required to pay the other half of their employment taxes, and you may be required to pay into workers’ compensation funds and pay additional unemployment taxes. As a result, you should anticipate paying 10-12 percent more in taxes and similar expenses when hiring employees as compared with contractors. Additionally, you should consider your administrative fees, like payroll expenses. (Chris uses Gusto (that’s his referral link) and says the platform and pricing works for his business.)

• Contractors: Among the best elements of hiring contractors is they are responsible for withholding and paying their own income taxes and also the entire amount of their employment taxes (Medicare and Social Security). You also can avoid workers’ compensation and unemployment taxes when you hire contractors. Clearly, this all makes paying contractors much easier than paying employees. But if you pay a contractor more than $600 in one year, you need to provide both them and the IRS with an IRS Form 1099. (To help you do this, always require your contractor submit a Form W9 to you before you pay them.)

Who Owns Intellectual Property

• Employees: The Copyright Act says the employer owns the copyright in works created by employees within their scope of employment. This makes it easy for you when hiring employees to create things.

• Contractors: But when you hire a contractor, it’s critical you get a copyright transfer in writing from the contractor. If you don’t, odds are the contractor will own all copyright in his or her work product because, without a writing, those works won’t constitute “works made for hire.”

What to Know about Termination Rights

• Employees: In most situations, your employees will be deemed “at will” employees. This means you (and them) can terminate the employment relationship at any time for any reason (but not for discriminatory reasons).

• Contractors: Your relationship with your contractors is a lot different. For the most part, your and their termination rights will be whatever your contractor agreement requires.

What the IRS Says

You should always be careful when classifying workers as contractors or employees because, regardless what you say, the IRS uses its own guidelines when deciding how you should treat your workers. Here’s a basic summary of how it classifies workers:

• A worker is likely an employee if (a) you control when, where and how the worker performs services; (b) you provide the worker’s tools and equipment; (c) you control how and when the worker is paid; (d) you give the worker employee-style benefits; and/or (e) the relationship doesn’t have an end date.

• A worker is likely an independent contractor if (a) the worker controls when, where and how he or she performs services; (b) the worker provides his or her own tools and equipment; (c) the worker controls payment terms; (d) the worker doesn’t receive employee-style benefits; and/or (e) the worker works on a project basis.

What You Should Do

Obviously, this decision can have major consequences, both good and bad, for your company.

One good practice is to engage new workers as contractors without employment benefits for some period of time, perhaps three to six months. Test them out, and if they are a good fit, then offer them employment with employment benefits.

You should also consider talking with an attorney to avoid making a wrong classification. If you do make a mistake, you may end up owing the government a lot of money.