Small Business Contractors and Employees
If you have a small business, choosing between hiring contractors or employees may be a crucial
decision. There are definite pros and cons to both working relationships, and, depending on your
small business, times where you may choose to employ both.
Whatever you decide, be sure to clearly outline the working agreement so that you can correctly
pay federal income taxes to the IRS.
Why is it important?
The definition of who is an employee and who is an independent contractor is not always straightforward. See IRS Publication
15-A, Employer's Supplemental Tax Guide, for a detailed description of how the IRS defines
each of these working relationships.
However, the major difference between contractors and employees is in payroll taxes. For
contractors, you generally don't have to pay or withhold any taxes at all. No withholding of
taxes. No Social Security and Medicare taxes. And no unemployment tax on wages paid to an
employee. However, you may be required to file "information returns" or Forms 1099-MISC to report
certain types of payments made to independent contractors during the year. Find more information
at the IRS
Web site.
Independent Contractors
Generally, contractors bring their own tools, set their own work schedule, and determine their
own work plan. Although you may be paying for the end result of their work, you are generally not
in charge of the method by which they reach that end result.
You can hire independent contractors based on project needs to keep your payroll lean. And you can
hire specialists as needed for your small business. Be careful if you're hiring contractors for product
development. You'll want to make sure that the intellectual property rights, or who "owns" the
product, are clearly defined for both you and the contractor.
Pros:
- Specialized services
- Tax savings
- Employee-benefits savings
- Hire workers as needed
- Fewer reporting requirements
Cons:
- Higher fees for specialized services
- Limited control over working methods of contractors
Employees
If you hire employees, you must withhold state and federal income taxes, withhold and pay Social Security and
Medicare taxes, and pay unemployment tax on wages.
However, there are benefits to having full-time or part-time employees. Employees may be hourly or
salaried, depending on the work plan laid out by the business. And, you generally have more
control over their work.
Pros:
- Employee benefits can build loyalty and increase retention
Cons:
- Employment taxes and benefits can be costly
Only you will know what is right for your small business. But whatever you choose, make sure you clearly
list the expectations of workers prior to hiring anyone. And, you may want to hire a contractor or
employee on a temporary basis to see if they fit with your overall business ideals.
