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Employee vs Contractor: Which Route Makes Sense for Small Business?

Posted by Pekin Insurance on Dec 12, 2016

Employee vs contractor? It's a question that's cropping up more and more for small businesses. Which is right for your company?

It's been a busy quarter for your business, and you've still got work lined up through the end of the year. However, you don't expect the extra work will last longer than a few months. A colleague suggests you hire a temporary employee to do the work, but another recommends a contractor. When it comes to hiring an employee vs a contractor, which is the best way to go?

The answer can be tricky. There are benefits to hiring both types of workers, but there are some legal risks as well, which can be difficult to navigate without the appropriate guidance. The following information is meant to be an overview, but you should always check with legal advisors about issues like this to make sure you're fully in compliance.

Employee vs contractor: The basics

There are a few primary differences between an employee and a contractor. An employee is someone who works for you at your discretion, during hours you determine, who receives instruction from you or one of your agents, and who is paid through your company payroll. Employees, whether permanent or temporary, use company equipment and space to perform their work, are eligible for any benefits you may offer, and receive a W2 at the end of the tax year.

An independent contractor is someone who works for him or herself or another company as a sole proprietor or an LLC. They work on a contract basis to perform a particular task or set of tasks, and you pay them through accounts payable as vendors. You cannot designate their working hours or tell them how to accomplish work assigned, however you can, of course, set deadlines. They are not eligible for company benefits, they should use their own equipment and workspace (except in extenuating circumstances), and they receive a 1099 at the end of the tax year.

Employee vs contractor: The benefits

There are benefits to both classifications of workers. If you hire someone as an employee, you have more jurisdiction over things like when and how they perform work for you, what equipment or tools they use, and where they work. And because most states in the United States have at-will employment, there tend to be fewer legal ramifications in the case of most separations.

Contractors, on the other hand, are attractive to employers because they tend to cost less. Employers don't have to incur the cost of benefits and other employee overhead, nor do they pay payroll taxes since the contractor is paid through accounts payable. Contractors also tend to work on fixed project, daily, or weekly rates, and they aren't eligible for overtime pay should they exceed 40 hours per week.

Employee vs contractor: The big risk

Though independent contractors are often more appealing, there are risks to classifying someone as a contractor if they should be an employee. You may have to pay fines and lost wages, offer benefits, and expect Department of Labor audits following an accusation of improper classification. The cost savings quickly disappear if you are caught misclassifying an employee as a contractor.

Employee vs contractor: Which is right for you?

Only you know if your business needs require an employee or a contractor. What's important is that you don't let the temptation of cost savings influence your decision. You have an obligation under the law to pay employees as employees when they meet the criteria. When in doubt, you're better off classifying someone as an employee, even if the worker is temporary (and even if the worker would rather be classified as a contractor—some would).

There are other minute details to consider as well, such as how many hours someone works for you, the length of a contract, and whether or not you ask someone to do work outside of the contract terms. Vet all of these things with legal counsel if they apply to your situation. If you're only looking for seasonal workers, like extra help during the holidays, they probably qualify as employees. If, on the other hand, you hire someone for a three-month contract to oversee a creative department, you'll need to consider other factors before you settle on a classification.

One last thing to keep in mind is that whichever classification fits, make sure you notify the employee and provide them with the correct paperwork. Many complaints and lawsuits result from improper notification, which can then cause the worker financial strife or other hardship at the end of the year.

Worried about your contractors? Make sure you have business liability insurance that covers you in case of a misclassification.

Have you had experience differentiating between employee and contractor? Tell us how you handled it in the comments below.


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