Contracting vs. Employing: An Essential Guide for Your Small Business

August 2021

As a business owner, you'll find yourself in situations where you might think Should I Hire an Employee vs. a Contractor? Keep reading to learn more about the pros and cons of hiring an Employee vs. a Contractor.

We came up with a concise guide to give you some details. Let's start by answering the following questions:

-What’s the best fit for my small business right now?

-Do I need a full-term commitment or to complete a short-term project?

-What will my responsibilities be as a company when hiring an employee vs. a contractor?

-What are the tax and labor laws implied in both processes?

What is an employee?

Quick quiz! What is the definition of an employee, according to the Internal Revenue Service- IRS?

A) Somebody that gets a certain sum of money every month for fulfilling specific tasks.

B) Somebody that owes you the result of their work.

C) Neither

The answer is C) Neither.

You might think that there are minimal differences between contracting vs. employing. But according to the IRS , under common-law rules, an employee is anyone who performs services for you is your employee 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 matters is that the employer has the right to control the details of how the services are performed.

Main advantages of hiring an employee:

-Commitment: Employees feel a certain connection with the company. Forming a cohesive work environment that can be positive for your small business.

 -Less expensive salaries: Hourly wage is usually lower than a freelancer’s fee because an employee feels secure having a stable day-to-day job.

-Steadiness: You can rely on them for several tasks and responsibilities during their paid hours. On the other hand, freelancers need to be booked if needed.

Beware! Don’t hire an employee if you don’t have:

-Time and resources for their training: Employees usually receive training, time to adjust to their new workplace, and they are provided with the equipment, and materials necessary to perform their work.

-Capital to invest in them: Employees receive insurance, contributions for their retirement, paid extra time, and social security, among others.

-Commitment to be legally subjected to federal state regulations on wages, salaries, overtime, and other implications. 

Full-time Vs. Part-time Employees

If you’re already convinced by the idea of incorporating an employee ask yourself: What type of compromise am I expecting from this person? What types of tasks and availability is necessary?

-Full-time employees can work between 30-40 hours a week and are entitled to receive most compensations and benefits.

-Part-time employees work a fraction of these hours and have fewer compensations. They typically do not receive paid vacations or holidays, nor benefits such as health insurance. Therefore, it is cheaper to hire part-time employees.

Important paperwork that you'll need when employing: Payroll taxes.

Employers are legally expected to collect and pay taxes throughout the whole payroll process. Here are some U.S. Federal payroll taxes components you should take into consideration:

-Federal Income Tax Withholding: Taxes withheld from employees pay for federal income taxes owed by the employees. The amount of federal income tax is defined by the information employees give in Form W-4 required once hired.

-FICA taxes: The Federal Insurance and Contributions Act taxes include Social Security and Medicare. A shared tax between employees and employers. The employer deducts the employee's share, which is one-half the total due, from employee wages/salaries, and the employer pays the other half.

-Additional Medicare Tax: Incorporated as part of the Affordable Care Act, employers withhold 0.9% Additional Medicare Tax on employees' earnings that exceed a threshold.

-Payment of unemployment insurance and worker compensation insurance.

What is a contractor?

Unlike employees who commit to working imposed hours to a company, a contractor has the freedom to decide their schedule, who to work for, and to have several employers at the same time.

Pros of contracting:

-Less paperwork and payroll obligations: Companies don’t have to withhold taxes from contracted, pay taxes or fees for their social security, health plan, and other benefits.

-You don’t need intensive time and skills to train them for a position: When it comes to training you don’t need to invest money in seeking, hiring, and training full-time employees.

-Reduced costs on equipment: An independent often provides his/her tools.

Beware! Don’t hire an employee if you don’t have:

-Short-term job in mind for them: Contractors are professionals with specialized skills, and sometimes they are the only option to cover a specific task during a specific timeframe.

-Trust in their work: You can assign duties to an independent contractor and impose a deadline and work product, but you cannot tell that person how to get the job done.

-Another employee to back you up in the long term. A contractor is not going to feel like part of your business as much as one of your employee's will. Most of the time they will limit themselves to doing the job assigned, without going the extra mile like a member of your team might go.

Important paperwork needed when employing:

When it comes to contracting, the legal implications are minimum. Independent workers are responsible for paying federal and state taxes. But remember if you opt for contracting your small business will be required to report their income to the IRS with the Form 1099-MISC.

Disclaimer: The content of this article is based on the author’s opinions and recommendations alone. This material has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, or accounting advice. We suggest consulting with your tax, legal, and accounting advisor before engaging in any transaction.