Contractors vs. Employees: Which Is Best for Your Business?

They say good help is hard to find, and that’s certainly the case if you’re a small business owner. But when it’s time to hire a few extra hands, deciding whether you want to use independent contractors or regular employees can be a big piece of the challenge.

So which is better when you consider contractors vs. employees? Contractors and employees both offer unique benefits for small business owners. It’s important to understand when to use each option, especially when you’re just starting your own business.This article will cover the pros and cons of contractors vs. employees for small businesses, as well as companies of all sizes. Keep in mind that your staffing needs may change as your business grows over time… So it’s critical to consistently reevaluate your strategies.

The Differences Between Contractors vs. Employees

Contractors and employees have a lot in common. There are some important differences that you should be aware of throughout the hiring process, though. 

Oversight

The main distinction is the level of oversight involved. While you can tell an employee exactly how to perform each task, contractors have the flexibility to get things done however they see fit.

You can set a deadline and identify a project goal when working with a contractor. However, they aren’t required to work on your schedule. This sometimes makes it more difficult to ensure quality performance… especially considering that contractors are typically used only for individual projects.

Employer Costs

Although you’ll still need to report the amount you paid an independent contractor each year on a Form 1099-MISC, you don’t need to withhold or pay FICA taxes on any payments made. The contractor will have to handle all of their own self-employment taxes themselves.

In contrast to independent contractors, hiring employees involves extra regulations for everything from paychecks to work rules. You’ll also need to pay payroll taxes plus half of all Medicare and Social Security taxes. Furthermore, managers are responsible for acquiring worker’s compensation insurance and unemployment insurance.

The extra costs that come with full-time employees are important to consider for any small business owner. Social Security and Medicare taxes add up to 7.65 percent of all wages, and unemployment taxes cost 6 percent of the first $7,000 in pay for each employee. You might also be responsible for other local and state taxes along with benefits and overtime.

On the positive side, managers have much more control over the day-to-day duties of their employees. If it’s important to you, you can also stipulate that they aren’t allowed to work for anyone else. With a few exceptions, you also have the power to hire and fire people at will without being responsible for any further costs as outlined in a contract.

When to Hire a Contractor

Every project is different, but there are some situations in which a contractor may be a more cost-effective solution. This is usually true for projects that aren’t a primary focus for your business. If you want a website, for example, you might not want to hire a full-time web developer. Instead, you could hire an independent contractor to handle that task for a fixed price.

With a contractor, you can simply agree to contract terms in advance and receive a finished product before the deadline. They might contact you with questions or concerns, but they’ll need much less oversight than a full-time employee. Contractors with a history of successful projects can be trusted to get the job done well and on time.

It makes sense to hire a contractor whenever there’s a clear beginning and end to a project. This can be everything from the website build-out mentioned above to getting your office space cleaned. Whenever there isn’t an ongoing need, you should consider a contractor. 

When to Hire an Employee

Cost is only one aspect to weigh when you’re considering hiring contractors vs. employees. Contractors are usually more affordable for small businesses, but at some point you’ll need to consider hiring your first employee. Employees come with a number of important advantages, especially for companies targeting expansion.

While contractors are typically best for one-off projects, employees are the best option for tasks that are critical to your success and require consistent work. Things like marketing, sales, and product development should generally be trusted to full-time employees with relevant experience.

You can’t work as closely with contractors vs. employees, so it also makes sense to hire employees for tasks that depend on regular communication or oversight. This also applies for jobs that call for specific tools or strategies that you don’t trust a contractor to use.

Every hiring decision is important, but adding employees to your business is a major commitment. Losing full-time employees is a significant cost, so it’s critical to find people you trust to grow with your business. 

Contractors are typically used for short-term jobs, so they don’t need to commit beyond the deliverable for each project.

Now, if you’re just starting out with your small business, you could always initially hire help as independent contractors. Then they could transition into employees once your business is thriving and you have the means to support them.

Incorrectly Classifying Employees

Contractors come with many financial advantages compared to employees. Unfortunately some businesses attempt to cut costs by classifying people as contractors when they should be paid as employees. The wrong classification can lead to large back payments and penalties, so it’s critical to make sure you pay everyone correctly.

The relevant legislation differs from one state to another, so a contractor in one state may be considered an employee somewhere else. Remember to learn about regulations in new states if your business expands beyond its initial location. 

The IRS uses three common law rules to determine whether someone providing a service is a contractor or employee. Keep in mind that the specific tests can be different in different states.

Behavior

Behavioral rules concern the work itself—if the company controls everything the worker does and how they do it, they’re likely an employee. On the other hand, completing tasks on their own indicates that they’re probably an independent contractor.

Finances

Usually contractors set their own financial practices. This can include when payment is expected as well as which side pays for things like tools and expenses. Employees, in contrast, are subject to the employer’s rules.

Working Relationship

The working relationship criterion covers much of what this article explains. If the employer offers vacation days, pensions, insurance, or other benefits, the worker is most likely an employee. By contrast, short-term working relationships that involve simple cash payment often means the worker is a contractor.

Alternatives

Most managers use some combination of contractors and employees, but these aren’t the only two ways to get things done. In fact, you could save a significant amount of money by tapping into alternative options before the competition. These strategies will help you achieve the same or even better results at a lower cost.

Freelancers

Some people think of freelancers and contractors as two words for the same type of worker. This isn’t true. There are important differences that make freelancers better in some situations. You also need to understand these differences in to accurately account for each type of worker during tax season.

The distinction between freelancers and contractors is somewhat blurry. Things are even more confusing given that many people use the words interchangeably. In general, freelancers are self-employed and pay their own taxes rather than receiving a 1099 like conventional contractors.

Freelancers tend to focus more on small projects, so they’re perfect for quick jobs that require a specialized skillset. You can use a variety of websites to connect with qualified freelancers in nearly any field.

Reskilling

Some jobs need someone who’s dedicated to a specific area, but you might be able to complete other projects in-house.

If you know a certain job will come up often, you should consider learning enough to do it yourself or delegating it to someone on your team. Flexibility is one of the most valuable attributes for employees. Each new skill they learn will have a positive impact on your bottom line.

Some jobs need more in-depth knowledge. Educational expenses for things like online classes are often cheaper than hiring a new employee or contractor. Keep in mind that it’s critical to achieve a high-quality result on every project. You should never attempt to DIY something if you don’t feel confident in your skills.

The difference between contractors vs. employees can be confusing for small business owners. But it’s crucial to understand when each option is right for your company. Hiring contractors for individual projects rather than adding a full-time employee to your staff could save you a substantial amount of money over time.

Logan Allec is a CPA, personal finance expert, and founder of the finance blog Money Done Right, which he launched in July 2017. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money.