When staffing your business, it’s important to understand the differences between employees and independent contractors. There are key differences in how they are paid and how you can control the way they get their work done. Hiring workers as independent contractors but treating them as employees can land you in serious trouble, which may include penalties, payment of back payroll taxes, and other expenses.
IRS Definitions
To start, here are the IRS definitions of these two types of workers:
- An employee is “anyone who performs services for you… if you can control what will be done and how it will be done. This is so even when you give the employee freedom of action.”
- An independent contractor is someone for whom “the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.
In other words, you can give an employee detailed instructions about how to arrive at a result, but you can only give an independent contractor the desired result.
For example, if you’re having a website built, the site is the result. You can tell an employee when and where to work on it, what tools to use, etc. But you can basically only give an independent contractor the specifications for the final product, while they retain control over how they get it done.
Paying Employees Versus Independent Contractors
One of the other major differences between employees and independent contractors relates to how you pay them.
When you pay an employee, you also pay federal payroll employer taxes, Federal Unemployment Tax Act (FUTA) taxes, state unemployment insurance in states where it’s required, and other applicable state and local taxes. Benefits, overtime pay, and worker’s compensation insurance are other typical costs associated with paying employees.
Independent contractors, on the other hand, are responsible for paying all of their own taxes on the income they receive from you. They are either classified as self-employed, or they may be employed by a third party vendor from which you are getting their services.
Deciding Between Employees and Independent Contractors
As a general rule of thumb, hiring employees tends to be best for any positions you need filled for the long-term that are directly related to your business. Independent contractors are best suited to short-term projects or those that support your business but are not directly related to its core products or services. For example, branding and marketing services are often outsourced to independent contractors at companies that aren’t large enough to have in-house marketing personnel or departments.
To avoid the potential for problems associated with hiring an independent contractor who should be classified as an employee, below are some major factors that point to your needing to hire an employee. As a generalization, if several or more of these apply to a job, you should hire an employee:
- You want to provide instructions for when, where, and how the person works
- You want work performed according to a sequence, schedule, or other plan that you provide
- You want work performed using equipment, supplies, or other tools that you provide
- You want to require full-time work
- The work being performed is integral to your daily business operations
- You will require the worker to undergo training
- You want to maintain an ongoing professional relationship with the worker
- You want regular reports about project activities or progress
- You want to control when and how the worker is paid
- You don’t want the worker delivering similar services or products for other companies while they’re working for you
- You want to retain the right to fire the worker at any time
