Employees and contractors—they’re basically the same thing, right? Not really.
Run payroll and benefits with Gusto
That’s like saying Superman and Batman are the same. Sure, they’re both caped crusaders, but while Superman uses his superpowers, Batman relies on his wits and smarts to fight crime.
Likewise, employees and contractors have distinct characteristics that set them apart from each other. And you need to know them, because there are serious consequences if you hire a contractor who should be an employee.
Here’s some information to know about hiring an employee versus a contractor to help you start thinking about which one is right for your business right now.
How are employees and independent contractors different?
They work differently.
Here’s a quick refresher on the definitions. According to the IRS:
- 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.” What this means is that even if you allow someone to work with minimal supervision or oversight, if you want to tell them what to do and how, you’ll need to hire an employee.
- An independent contractor is a worker 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, when you hire a contractor you can only control the outcome or deliverable—not how the work is performed.
For example, if you hire a web developer to build a website, the result of the work is the website. You can dictate that you want a six-page website with unicorns and rainbows on it. Assuming the developer is an independent contractor, you cannotdictate that you want the developer to work every Tuesday for three hours, in your office, using your computer, following a specific workflow.
You pay them differently.
There are a few key differences in the way you pay a contractor versus an employee.
When you pay an employee, here are a few things you have to cover:
- Federal employer payroll taxes. These taxes amount to 7.65 percent of the employee’s wages and go towards covering a portion of their Social Security and Medicare.
- FUTA taxes, which is 6 percent of each employee’s first $7,000 in wages.
- State unemployment insurance (SUI), if required by your state.
- Any state and local taxes.
Other costs associated with hiring employees are:
- Benefits packages
- Overtime pay
- Worker’s compensation insurance
Whoa! That’s a lot of money to pay on top of employee wages. Is there another way? Well, yes: contractors.
Contractors are usually classified as self-employed individuals or individuals who are employed through another entity, such as an outside vendor, which means they are responsible for paying their own taxes. Unlike employees, who you split the tax burden with, when you pay a contractor you do not pay any payroll taxes.
Sweet! So why would I ever hire an employee?
Because, in the eyes of the IRS (and also in the eyes of state courts!), employees and contractors are not interchangeable. Each has its own legal classification, and if you hire someone as a contractor who should be an employee, you can get penalized and be subjected to retroactive payroll taxes and other costs. In other words, you will get in trouble and pay the government (and maybe even the individual employee in question) lots of money.
Keep in mind, just because someone agrees to be hired as a contractor does not mean they are legally a contractor. Recently, one of my clients was audited by her state’s employment agency. Even though all of her staff agreed to work as contractors and signed independent contractor contracts, they were still found to be employees.
The result? All staff had to become employees and she paid five months in back payroll taxes and penalties, totaling $15,000.
Finally, they can help you in different ways.
If you need help on a short-term basis or with work that supports your business but is not part of your core product or service, then you might want to think about hiring a contractor. Let’s say you run a fitness studio. Examples of contractors could be:
- Logo designer
- Monthly bookkeeper who works remotely
- Copywriter for a new website
- Photographer for headshots
Notice how all of these roles have specialized skills that fall outside of the operation of your business? And, with the exception of the bookkeeper, all of these examples are short-term jobs with a clear deliverable.
If you need help on an ongoing basis and with work that directly impacts the operations of your business, it might make sense to think about hiring an employee. Employees don’t just offer a single deliverable, but rather ongoing support. Examples of employees for a fitness studio could be:
- Administrative assistant
- Trainers who teach classes on an ongoing basis
Hiring an employee versus an independent contractor
Free employee versus contractor cheatsheet.
First, assess your needs. Think about what type of help you need and what hiring resources you have available.
Then, here’s a list of questions you can ask yourself about the role you have in mind. Once you’ve had a chance to think through these, contact an attorney or advisor who can walk you through the employment classification laws in your state.
Generally, the more “yes” answers you have, the higher the chance that you need to hire an employee rather than a contractor.
Will the worker be required to follow your instructions for when, where, and how to work?
Will the worker need to perform tasks according to a sequence or schedule you set?
Will the worker work on your premises or at a location you choose?
Will the worker use equipment, tools, materials, or supplies that you provide? Typically, contractors make their own investments in tools and equipment.
Will the worker need to work during designated hours? For example, will they need to be at your location from 10am–5pm every day?
Will the worker be required to work full time? If so, you’re restricting their ability to work outside of your business and this indicates they are an employee.
Is the work being performed integral to your regular business activities? In other words, does running your business depend on the work they’ll be doing?
Is training required? Usually, independent contractors don’t require training as they are already skilled in their trade.
Does the worker have an ongoing relationship with you? If someone works for you on a regular basis, it’s usually an indication that they are an employee.
Will you need the worker to submit reports about their activities? If so, it shows that you have an interest in how the work is performed.
Will you pay the worker a fixed salary, an hourly wage, or on a fixed rate per item produced?
Will you control how and when the worker gets paid? Contractors are paid per job and they bill for their services, generally, once the job is complete.
Is the worker allowed to work for multiple companies at once? If you need them to work with you exclusively, then you’ll want an employee.
Are the worker’s services unavailable to the general public? If a worker does offer their services to the general public, it indicates that they are a contractor.
Can you fire the worker without cause? The right to fire a worker is an employer right. Independent contractors are hired to perform a job and cannot be fired unless they violate the terms of their contract.
Can the worker quit at any time? Just as an independent contractor cannot be fired unless they violate the terms of their contract, they also are contractually bound to finish a job.
What does this actually look like?
Let’s walk through a couple examples together—but remember. These examples are for informational purposes only and aren’t hard and fast legal advice. You should speak with an attorney or advisor in your state to determine how to properly classify your new hire.
Jacob owns a hair salon and wants to hire a front desk person to work 10 hours a week. This person will check clients in on the salon computer, answer phones, schedule appointments, process sales, and perform end-of-day closing tasks. Jacob will train the desk person on all salon procedures. The person will need to work on Mondays and Wednesdays during the salon’s business hours.
Based on the IRS’s definition and the scope of the role, Jacob should probably consider hiring an employee. Here’s why:
- Jacob wants to dictate the tasks that the desk person will perform. They won’t have freedom over what they will do while they are working for Jacob.
- The desk person is required to work on-site, at specific times, on an ongoing basis. Jacob controls the schedule.
- The work will be performed using equipment and supplies Jacob provides. The desk person isn’t going to bring their own computer and phone to schedule appointments. They’ll use items owned by Jacob.
- The job requires training, which is done by the employer (Jacob).
- The desk person plays an essential role in the primary function of Jacob’s business. Without the desk person, some of the salon’s day-to-day activities would not be performed and Jacob could not book appointments.
Jacob wants to boost his marketing efforts. He decides to run a Facebook ad campaign and wants to hire a Facebook ads manager to design and execute his campaign. It’s a six-week gig, and Jacob wants the manager to create three separate ads and set up the campaign on Facebook.
In this case, Jacob should probably consider hiring a contractor. Here’s why:
- While Jacob controls the outcome of the job (three ads plus campaign setup), he does not dictate how the ads manager will perform the work or the tasks involved.
- The manager decides when they will work, for how long, and is not working at Jacob’s salon.
- The job is for a defined period of time and has a clear completion date and objective.
- The manager will use their own computer to perform the work.
- The job does not require training because the manager is an expert in their field.
- The manager offers Facebook ad services to the public and works for multiple clients at once.
- The work performed is outside of the core function of Jacob’s business. While the ad campaign will be beneficial to Jacob’s business, the manager is not performing work that directly relates to salon activities.
Now, it’s time to go out there and get the process started. Who knows, you might even hire a hero in disguise.
Note: The opinions expressed in this article are those of the author and do not necessarily represent Gusto’s views.
None of the information in this article is intended to be legal advice. Be sure to speak with your attorneys and advisors about employment classification laws in your state, because rules can vary state by state and penalties for misclassification can be steep, depending on your circumstances.