Defining the needs of the business is a crucial factor that entrepreneurs must deal with. One of these needs is the types of workers they would want to contribute to their business. Knowing when to hire an independent contractor versus an employee for your business is crucial because of all the legal factors involved. Setting a standard in identifying the differences for proper classification is necessary for setting policies for hiring and managing the workforce.
Employees vs. Independent Contractors
Some business types will have employees and independent contractors working together, with some executing similar job descriptions. One of the significant differences between the two types of workers is the level of control an employer has over them. Employers have direct control over where, how, and when the employee should perform their job. Whereas, for independent contractors, the employer has the final say only on the outcome of the product or service rendered.
Astute business owners know that classifying an employment type has legal implications. Making a simple mistake cause unnecessary costs and potential damage to the business. However, not many entrepreneurs are aware of this.
By law, employees are salaried workers paid hourly, on commission, or both. These employees may be required to work overtime. The taxes these employees must pay depends on their income. For employers, this means they have to withhold state, federal, and FICA taxes.
Independent contractors, on the other hand, provide their skills and expertise. Employers do not have to withhold taxes or process FICA tax payments. In essence, independent contractors are like business owners who provide services to fellow business owners requiring their expertise. These contractors are responsible for paying their self-employment taxes to the IRS.
The Advantages of Hiring Employees
As mentioned, hiring an employee means having full control and direct say on the individual’s tasks during his working hours. Employers can also provide training to teach how a particular job must be done. They can also demand employees to work for them exclusively. However, this control comes with tons of compliance with laws and regulations. For instance, employers have to comply with federal and state laws in terms of payment of wages and salaries, overtime, and other work regulations and requirements.
The Advantages of Hiring Independent Contractors
Employers who choose to hire an independent contractor has limited control over their work. While they can assign tasks and impose deadlines, employers cannot demand to control how the contractor does their job. Additionally, independent contractors have the liberty to work for other employers or business owners who might need their expertise.
Since the company does not employ independent contractors, the employer is not, in any way, responsible for reporting tax responsibilities.
When Should You Hire an Employee?
Employers must hire an employee if:
- The job requires direct supervision by the management.
- Employers want to control working hours, tools, and equipment necessary to get the job done.
- If the company needs the position for a long-term project.
- If the job role is integral for business operations.
When Should You Hire an Independent Contractor
Employers must hire an independent contractor if:
- The job role is not within the scope of the business vision.
- The task can be accomplished best by a professional who does not require direct supervision.
- The role is for a short-term project.
Hiring an employee or an independent contractor is a decision that depends on business needs. However, employers need to know that the IRS will classify any worker as an employee unless you can prove that they are not.
How Does the IRS Classify Worker Status?
The IRS identifies an employee from an independent contractor to process their payroll and withholding tax. To do this, the IRS has set three (3) general criteria in classifying a worker either as an independent contractor or an employee:
Behavioral Control. The IRS classifies the worker as an employee if the business has control and directs the tasks needed by the worker. The categories of behavioral control include:
- Type of instructions given
- Degree of instruction
- Evaluation systems to measure performance
- Training a worker for the job
Financial Control. This component pertains to contributing factors that include:
- Means of how the worker receives their salary
- The ability to work for others at the same time
- Whether the worker incurs a profit or a loss because of non-reimbursed expenses
Type of Relationship. This factor defines how the workman and the business interact with each other, and it covers different aspects such as:
- Written contract
- Permanency of the relationship
- Services provided
Assume Every Worker Is An Employee
Despite the IRS’s effort in setting the general criteria for classifying workers as an independent contractor as opposed to being an employee, sometimes it is hard to verify a worker’s status. Here, you can request a determination from the IRS by filing Form SS-8 (PDF).
Keep in mind, however, that the IRS does not issue determinations based on hypothetical situations. Based on the instructions on Form SS-8, it is clearly written:
“Neither the Form SS-8 determination process nor the review of any records in connection with the determination constitutes an examination (audit) of any federal tax return.”
Another Possible Status for Workers
Besides the ever confusing status of workers as previously mentioned, another possibility for a worker’s status is a statutory employee, also known as a non-employee. This status is a cross between an independent contractor and an employee. Employees under this status are considered as an outsider but are managed like an employee regarding employment taxes while they are treated as independent contractors for income taxes.
Specifically, statutory employees can only be assigned to four (4) categories:
- Full-time life insurance agents for a particular company
- Company drivers who are paid on commission and distribute (non-milk) drinks, produce, meat, and bakery products.
- Home-based employees doing piecework on materials or supplied goods.
- Full-time sales representative
When unsure of the workforce requirement of your business, it is best to consult a lawyer or your company’s HR Department. They can advise you if a particular job role necessitates an employee or can be best done by an independent contractor.