Growing your team is an exciting (and scary) thing for small business owners, especially when it comes to classifying team members as employees or contractors.
What’s the difference between an employee and a contractor?
Employees (often referenced as “W-2” because of the IRS W-2 form sent to the employee at year-end) are people dedicated to your company. Whether they’re full-time with a salary and benefits, or part-time hourly remote workers, employees are focused on your company as their main job, and you control the work they do.
Contractors (or “1099s” because of the IRS 1099 form sent to them at year-end), on the other hand, are experts in their field who are running their own businesses. Unlike employees, contractors control their own work and figure out how to accomplish your desired outcome.
As an example, if you need a new website, you could hire an experienced contractor to complete the project. You are unlikely to tell them to use a particular design software or how to go about coding a page, rather you’d provide specific requirements and they’d figure out how to deliver them.
Unfortunately, not every role is as clear-cut. The first member of the team is often a part-time assistant to the business owner whose hours vary, and it’s tempting to try to hire them as a contractor because the paperwork is less complex.
Employee or Contractor?
The truth is that it’s not really your choice; it’s a factual classification based both on the job requirements and the individual you choose to fulfill them. The IRS has rules on what makes a contractor, but even the IRS says “There is no “magic” or set number of factors that “makes” the worker an employee or an independent contractor…” so how are you supposed to know? Let’s take a closer look, using our example of an assistant.
Chances are, you’re providing a list of tasks to your assistant and giving them clear direction on how you want things accomplished. Because you are controlling their work, the IRS would likely classify them as an employee.
An exception would be if you contract with a company that provides virtual assistants. Even though you still have an assistant for whom you are controlling the work, you are paying the larger company, not the individual. Essentially you are hiring a staffing firm, not an individual.
Which one is “better”?
When business owners worry about what’s better, they are often thinking in terms of cost. Is it better to pay a higher hourly rate to contractor, or bring in an employee that may have a lower hourly rate, but will require you to pay taxes? Let’s use social media as an example to explore this.
If you bring on a social media contractor, you’ll be gaining a team member with expertise on social media. They’ll likely be familiar with different platforms and strategies to get your audience engaged, but they won’t be familiar with your company. A contractor is an outsider, who might be able to create great content, but they will only know what you take the time to tell them.
Alternatively, if you brought on an employee to do social media, chances are they would not have the same level of social media expertise as a contractor. But they would know your company from the inside out. In this case you might give up a sophisticated growth strategy, but have authentic content.
What’s better? That’s a choice about what’s most important to you – expertise vs. inside company knowledge.
The person matters
Let’s go back to our example of an assistant and say you had initially hired them through a virtual assistant company. At some point they decide to leave the company, but you decide to keep working together. You’ll now be paying them directly, so would they be a contractor or an employee?
While you may still consider the role as something that can be outsourced to a contractor, if the person is now working for you, and no one else, then you might want to hire them as an employee to minimize your risk. It doesn’t matter if you only pay them 10 hours a week, and if they have the intention of gaining other clients.
It also doesn’t matter if they want to be a contractor rather than an employee – it’s not their choice any more than it’s yours. If you are their only source of income, the IRS is not likely to believe that the individual is truly an independent business (contractor) because they’re not operating as a business.
That’s a lot to think about and you can see how things can get confusing. Fortunately, there’s a fairly easy way to do some research: the internet.
Search for the person you’re planning to bring on board. Did you find a website for them that shows they are actively marketing their services, or just a resume? Have they registered their business with their state agency? (Note that some states don’t require sole proprietors to register, so this test is not definitive.) If they are registered to do business, and are actively marketing their company and services, and are serving multiple clients, it’s less risky to treat them as a contractor. If you can’t find any evidence of their business activity, you might want to consider them an employee.
What if I get it wrong?
Treating someone who should be an employee as a contractor can come with penalties if the government discovers your mistake, and it can be costly. Read more about the risks here, or contact us today to learn the best way to grow your team.