It doesn’t matter whether you consider the individuals you employ employees or independent contractors. Ultimately, the IRS or the Department of Labor will decide how your workers should be categorized. The truth is you don’t get much say in contractors vs. employees.
In the end, it all comes down to the work the worker performs and how you manage the work they perform. Let’s dig into this deeper as we explore the pros and cons of contractors and employees.
Employee or Independent contractor?
Generally, if you control the individual’s actions, that person will likely be considered an employee of your business. If the individual does not have an independent company exclusive to yours, that suggests an employee.
If you supervise the individual’s work, this is another factor to consider for an employee. And importantly, supplying the individual with tools, materials, and a workspace will also be considered in determining an employee relationship with your business.
However, if an individual is retained for a specific project, for a limited time, or is paid per project, such factors indicate a contractor relationship.
Don’t make decisions about classifying individuals in your workplace without consulting a lawyer about it first. The last thing you want is to misclassify someone as a contractor, only to have the DOL or IRS tell you otherwise. That can subject you to severe fines and payment of past-due taxes and benefits.
Just ask Steak ‘N Shake, which made a $7.7 million error because it misclassified its workers.
The Pros and Cons of Contractors vs. Employees
We’ve got a whole post on the differences between full-time employees vs contractors here. But today, we’re focused more on the pros and cons of each rather than their definitions.
The Pros of Hiring an Employee
Employers have the most significant degree of control over their employees. Not having to worry about the IRS or the Department of Labor reclassifying the people who work for you and avoiding harsh penalties if you do are two main benefits of hiring employees as opposed to contractors.
The good news is, the employer has already completed the necessary withholdings for taxes and unemployment. Additionally, the employer can regulate the employee’s working hours and oversee the quality of their job.
Along with adding new skills and expertise, hiring staff people can increase output and efficiency. Employees can expedite company operations and free the owner from focusing on other business-related tasks. This is helpful for small companies in need of extra assistance or who feel overworked.
Recruiting staff may provide opportunities for professional advancement for both the employer and the employee. Workers with knowledge and training from their businesses are more equipped to offer original ideas and perspectives.
With the help of an employee, you may also complete more tasks in less time, giving you more time to focus on other elements of your business. This is helpful if you need more time when you get overworked or stretched too thin.
Hiring a worker may also allow you and the employee to grow your careers. You can share your knowledge and experience with the employee, who might offer new perspectives and creative ideas.
Cons of Hiring an Employee
On the flip side, hiring employees does come with some problems. Most of them are financial in nature.
For example, the employer must carry workers’ compensation insurance by having employees in almost every state. Most states require an employer to carry workers’ compensation insurance if they have at least one employee.
Note, if it’s owner-operated, and the owner is the only employee, usually the owner can opt out of the insurance requirement.
Further, income tax and unemployment withholdings are additional financial burdens the company will have to take on while maintaining its employees. We often see new business owners try to classify their workers as independent contractors to avoid these costs.
This ultimately creates problems, especially if the employee leaves under unfavorable circumstances. You can likely expect a call from your local unemployment investigator.
Wage hour claims
Some additional problems with hiring employees include being subject to wage-an-hour claims, where the employer is responsible for paying the employee more for working overtime. The employee usually initiates such an investigation by filing a “wage-hour complaint” with the local department of labor offices.
Further, employers are subject to anti-harassment and discrimination laws and Family Medical Leave Act (FMLA), ERISA, and OSHA requirements when they have employees. These regulations and laws expose the employer to additional financial exposure and liability if you don’t follow these rules correctly.
These cost and wage benefits can be a significant financial commitment, especially for small businesses. Hiring an employee requires a substantial investment of time and effort. Recruiting and interviewing are time-consuming, especially if you need to familiarize yourself with the hiring process.
There are also other expenses to consider, such as training and equipment. As an employer, you have legal responsibilities, such as withholding taxes and complying with labor laws. This can be complex and may require the help of a legal or HR professional.
Finally, there is also the risk of employee turnover—this can be costly and disruptive to your business. This can be incredibly challenging for small businesses that rely heavily on a small team.
Speaking of your team, here’s why a startup lawyer should be on it!
The Pros of Hiring a Contractor
Using a contractor has the benefit of requiring less management labor and financial investment to keep them in good working order. The contractor’s employment is also excluded from ERISA, FMLA, workers’ compensation, and overtime laws.
Additionally, employers are not required to withhold taxes or unemployment insurance from contractors’ compensation. As mentioned above, employers frequently categorize their personnel as independent contractors to avoid these extra costs.
Flexibility and cost-effectiveness
One of its key benefits is the flexibility and cost-effectiveness contractors can offer to a business. Since businesses often recruit contractors as needed, companies can only add more talent if they commit to recruiting an employee. This can be particularly beneficial for businesses attempting to grow into new markets or with varying workloads.
Instead of hiring a full-time employee, a business launching a new product line could choose to work with a contractor with experience in product development. By doing this, the company can hire specialized knowledge without paying long-term employee costs.
Furthermore, contractors are typically liable for their own taxes and benefits, which can save your company money.
Here’s another article you don’t want to miss next: Choosing the Best Business Entity for Your Startup
The Cons of Hiring a Contractor
You should always hire an independent contractor with a contract in place. Employers too often rely on handshake deals to secure contractor services.
Additionally, employers commonly misclassify workers as contractors when they should classify them as employees. As mentioned earlier, such misclassification carries a hefty price tag.
If you hire a contractor, you may incur charges for taxes, benefits, and other costs you would face if you had hired them as an employee.
On top of legal repercussions, contractors may not always be an excellent fit for a business’s culture. Contractors typically look for short-term gigs and don’t always invest in the company’s long-term success.
Conclusion: Contractors vs. Employees: Pros and Cons
For companies that can afford to bring on an employee, having a dedicated team member who is invested in the long-term success of your business may be the better choice. However, utilizing independent contractors can be beneficial if you’re looking for short-term assistance or are working with a limited budget.
But remember, misclassifying employees as contractors can come with substantial legal and financial risks. If you have questions about classifying workers or other employment law issues, lean on a team of experienced Denver business lawyers like those at Contiguglia Law for assistance.
And remember: My book “Don’t Skip the Legal: The Startup Guide for Entrepreneurs and Business Owners” covers contractors vs. employees and other legal topics in great detail. It’s available on Amazon—buy your copy today!
Did you learn a lot about contractors vs. employees in this post?
Here are three more to read next: