The best type of worker to hire for your business – an employee or independent contractor – depends on several factors, like cost, company culture, desired skills and flexibility. However, how to classify your workers is not as simple as you might think, as there are several legal guidelines you must follow to determine whether you should classify them as employees or contractors. Learn what those differences are, and which type of employment arrangement is best for your business.
Classifying contractors vs. employees
An employee is a permanent member of your company who must be treated in accordance with federal and state labor and wage laws. An independent contractor operates under a separate business name from your company and performs job functions for you on a temporary basis.
The U.S. Internal Revenue Service (IRS) has pretty strict guidelines about when someone must be classified as an employee or an independent contractor, which are primarily based on the degree of control and independence the worker retains. The three categories the IRS uses to classify these are behavior, financing and relationship type.
To determine the degree of control your worker has, ask yourself the following questions:
- Does the person work on company premises? Employees are more likely to work onsite, whereas independent contractors can typically work at any location of their choosing.
- Is the person using their own tools? You are responsible for providing employees with the necessary tools to complete a job, whereas independent contractors are typically responsible for their own tools.
- Is the person in control of their own schedule for completing work? Employers can dictate their employees' schedules and work output, whereas contractors have more control over when and how much they work.
- How is the person being compensated? Independent contractors are typically paid by their output, not their time. Additionally, you are not responsible for paying a contractor's benefits or employment taxes, carrying their workers' compensation policy, or withholding their income taxes.
Although the main differentiator of worker status comes down to control, the dividing line between an employee and an independent contractor is not always that simple. For example, you may also have to consider the type of job function being performed in comparison to your specific business trade. Andy Contiguglia, business risk management consultant and owner of Contiguglia Law Firm, provided an example of how two different job types may be classified for a web design company.
"A web design company that hires a programmer as an independent contractor is likely to have that person classified as an employee, because they engage in the work the business delivers," Contiguglia told business.com. "Compare that to the same web design company hiring a photographer to take pictures to be included on a website. The design company and the photographer are engaged in different businesses."
Another thing to consider when classifying workers is how their classifications might change over time. Contiguglia said that, if the IRS or Department of Labor reclassifies your workers from contractors to employees, you could be subject to serious fines and payment of past-due taxes and benefits.
What are the pros of hiring an employee?
Hiring a full-time employee has many advantages. It is best for employers who want consistent, long-term team members who are invested in building company culture and achieving your mission. Here are the biggest advantages to hiring employees, according to the business experts we spoke with.
Company culture and mission
Employees are immersed in and perpetuate your company culture. They are often more engaged and motivated to work hard and achieve your company's goals and long-term success.
Employees should be viewed as long-term investments. As you spend money on training them and developing their skill sets, your organization will reap the benefits. Employees understand the internal workings of your company that can be beneficial in marketing your business. They are also more likely to remain loyal to the success of your company.
"While a contractor might only care about getting the project done and getting paid, a long-term employee may be more willing to exceed expectations and put in extra effort that your business will benefit from for years to come," said Chane Steiner, CEO of Crediful.
Since you have more control over your employees than you do contractors, you can alter their workload to best fit the needs of your business. If your company suddenly needs to change course, it is easy to adjust an employee's tasks or assignments without renegotiating a contract.
Consistency and control
When you hire employees, you have a reliable, consistent team to work on projects as needed. You won't have to constantly negotiate contracts with new talent and wonder if they are capable of completing the tasks you hired them for. You can also control your employees' schedules to ensure that the work is produced at the proper pace.
What are the cons of hiring an employee?
Although there are many advantages to hiring employees, there are a few setbacks to be aware of as well. Here are the biggest disadvantages to hiring employees, according to business experts.
Hiring employees comes with several additional expenses that are not required for contractors. For example, your company is responsible for paying employees' wages, benefits, employment tax, income and unemployment tax withholdings, workers' compensation insurance, overtime pay, and training expenses. You will also likely be responsible for fringe benefits like health insurance, dental and vision plans, retirement contributions, and paid time off.
"These expenses are necessary for keeping an employee over a long period of time, and, depending on the needs of a company, full-time employees can be significantly more expensive than contractors," said Steiner.
It is important to provide your employees with growth and development opportunities so they can enhance their skills and improve upon the work they produce for your company. If you do not provide the proper growth opportunities for your employees, they will either stagnate or leave your company, increasing your turnover rate. Providing the right opportunities for each employee can be a challenge and is not something you have to consider with contractors.
Federal and state labor laws
Employees are protected by several federal and state labor laws, which can cause legal and financial setbacks for some companies. For example, if your employees work more than the legally allotted time (typically 40 hours) in a week, you are responsible for paying overtime wages.
"With employees, employers are subject to anti-harassment and discrimination laws as well as Family Medical Leave Act (FMLA), ERISA, and OSHA requirements," said Contiguglia. "Each of these regulations and laws expose the employer to additional financial exposure and liability if not properly followed."
What are the pros of hiring a contractor?
Hiring an independent worker as a contractor has its own set of advantages. It is best for employers who want highly skilled, short-term team members who can perform without supervision or company-supplied tools. Here are the biggest advantages to hiring contractors, according to the business experts we spoke with.
Advanced skill sets
When you hire a contractor, you are hiring someone who has the specific set of skills needed to accomplish the task or project at hand. There is often a wide pool of competitive talent to choose from, which can be a great way to get superior project results. This is especially beneficial if you are looking for someone with a very niche set of skills for a highly technical project.
"Instead of having to hire full-time employees who may have to wear many different hats by taking on a variety of tasks, hiring contractors with the expertise to fill a temporary need can be a great way to complete a large variety of work," said Steiner.
Contractor agreements are for short-term work, so you are not locked into a large investment. It is also easier to dismiss a contractor than an employee. Most independent contractor agreements specify employment at will, which means contractors can be let go without legal implications. This is advantageous if you hire a contractor who isn't the right fit for your company. Your business is also not typically liable for injuries a contractor may obtain while working for you.
Contractors have control over their work schedules, which reduces your need to supervise and manage the worker. Instead, you can expect the contractor to work under their own supervision and manage their time accordingly.
You will have to pay your contractor the agreed-upon wages, but you are not responsible for the additional costs and obligations that come with an employee, like workers' compensation, overtime, employment taxes, benefits, FMLA and ERISA.
Keep in mind that, with contractors, you get what you pay for. Be prepared to pay them a higher wage than you would an employee, since they are responsible for paying their own employment tax, income tax, etc. Experienced contractors know their worth. Undercutting a contractor will likely yield poorer project results.
What are the cons of hiring a contractor?
Although there are many advantages to hiring contractors, there are potential downsides. Here are the biggest disadvantages to hiring contractors, according to business experts.
Lack of culture or brand loyalty
It is difficult to foster team and company loyalty from contractors. Because of the need to draw a firm line between employee and contractor, workers with independent contractor status are not invited to outside company functions such as motivational seminars, team-building exercises, celebratory events and developmental training. This kind of separate treatment can easily make contractors view their work as just a job, and not worth expending any effort beyond the minimum required.
Limited product or company knowledge
Contractors are only with your company for a short period of time, so their knowledge of your company and product will be limited. Although they can do the necessary research to complete a project for you, they will lack the insider brand knowledge that can only be learned over a longer time with the company.
"If you're hiring contractors to produce any work that is designed to convey the mission and brand of your company (such as marketing), it may be better to go with a full-time employee that's more involved with your company, with a better understanding of it as a whole," said Steiner.
Just as you can terminate any contractor at will, contractors are free to move on to the next job with little or no notice. While it's true your own employees could do this too, because there are time restrictions on the terms of a contractor's job, they are much more motivated to be on the lookout for the next job opportunity elsewhere. Critical job functions may be impaired if a significant percentage of your workforce is prone to high turnover and lack of commitment.
Inconsistent product quality
Since an independent contractor can only work for you for a short period, you will constantly have to look for new talent. When you hire a new contractor, you must learn their product output, communication style and management capabilities. Although many contractors are highly skilled in their craft, you run the risk of hiring inconsistent or unmotivated workers. Hiring various levels of contractors with inconsistent product quality can reflect poorly on your brand.
Contractors vs. employees – what is better for your business?
Although a worker's status as an employee or a contractor depends on several legal factors, the best type for your business depends on the needs you are trying to fulfill. What level of flexibility, control and time commitment do you need?
"An individual who is going to be working on multiple projects and is subject to a significant amount of employer control should likely be classified as an employee," said Contiguglia, "while [for] the worker coming on board for single project, or project outside of the scope of the employer's business, classifying that person as an independent contractor might do the job."
For many businesses, a hybrid approach is best, hiring a set of full-time employees for recurring tasks and contractors for occasional projects. When you're determining the employment status of your workers, it is always advisable to consult a lawyer or human resources representative to avoid misclassification.