Employees or contractors?

4 ways to help determine which is right for your business

Red Dot Advertising + Design in West Des Moines has a full-time team that handles most of its client projects, but there are times when the company turns to trusted independent contractors to perform specialty services.

The decision of whether to hire part- or full-time employees or to rely on independent contractors — or even a combination of the two — is one that many small business owners make. It’s important business owners understand there is a difference between the two, according to the U.S. Small Business Administration (SBA).

The difference can mean using one over the other, but it can also affect how taxes are withheld and other legal issues.

Red Dot, a branding and advertising firm, hires independent contractors when a client needs a service that the company doesn’t provide, or if they need help to fulfill basic day-to-day operations, says Desiree Fletcher, a public relations strategist for the company.

“This model allows us to be nimble and flexible, providing just the right services for each client partner as effectively as possible,” she says.

Here are four things to ask yourself when choosing to hire an employee or an independent contractor.

1. What’s the difference?

An independent contractor varies from a hired employee.

The SBA outlines the differences: An independent contractor operates under a business name, maintains a separate business checking account, advertises services, invoices for performed work, has more than one client, uses his or her own tools, keeps business records and sets his or her own hours. Independent contractors are responsible for paying their own Social Security and Medicare withholdings, as well as state or local taxes.

A business owner has more control over an employee. An employee performs duties dictated or controlled by others, receives training for their job and works for only one employer, according to the SBA.

The SBA also recommends the employer or business owner consider how integral the services being performed are to the business, the permanency of the relationship, and, most importantly, how much control he or she has over the work being performed. The latter usually can be a deciding factor in deciding whether the person is an independent contractor or an employee.

Fred Anderson, an attorney who specializes in business law at Shindler, Anderson, Goplerud, Weese Law Firm in West Des Moines, says he goes over a 20-point checklist with his business owner clients when they are considering whether to hire a contractor or an employee. This checklist includes identifying the job responsibilities, location of the job, who will be the supervisor, and what tools will this person use to perform his or her job.

The Internal Revenue Service website has a guide for determining independent contractors versus employees: www.irs.gov, which Waukee Certified Public Accountant Dawn Lull says is a good tool.

A good rule of thumb is if the employer has control over how the work is done and gives the person the tools to do their job, then they’re an employee, she says.

Business owners who want to hire independent contractors will need to make sure they have an agreement with them that stipulates the contractor will cover his or her own insurance and healthcare and pay his or her own taxes.

“Really, the business owner treats them like any other vendor,” Lull says. “They don’t care how the work gets done; they just need it to be done.”

2. What are your needs?

Independent contractors can be a way to help a small business fulfill staffing needs or perform specific projects. A single contractor can be hired for multiple jobs or only once if it’s not a good fit for the business.

For Red Dot, independent contracts are hired depending upon the project, and it’s mostly to conduct specialized research. This accounts for less than 10 percent of the company’s work, Fletcher says.

The company has eight full-time employees and has grown organically during the past 15 years. Individuals were hired as the company grew its core services. If the company got to a point where it constantly needed to hire independent contractors, Fletcher says it may look at hiring a full-time employee to perform those services.

Independent contractors also can help fill a need for seasonal businesses that experience increases and decreases in their staffing needs. A contractor can be hired to work on a particular project or for a particular period of time, depending upon their agreement with the business owner.

That’s the case for State Public Policy Group (SPPG), a West Des Moines company that is hired as a private contractor for other businesses that need project or issue management.

“We will sub with other individuals if we don’t have the in-house expertise to do the work,” says Arlinda McKeen, the company’s chief executive officer.

Recently, the SPPG hired independent contracts to provide coaching for an after-school program for a client.

“That is something that requires some educational background,” McKeen says. “We do not have that educational background.”

Most of the time, the sub-contracted work is a portion of a larger client project.

“This would be in a larger contract where we would provide the core services, but if there’s something special (within the contract) we need to sub-contract for, we will do that,” McKeen says.

Lull says most independent contractors are hired for service-type jobs such as accountants, engineers and sometimes construction workers. Retail and restaurant jobs would be classified as employees because the individual is given the tools to do his or her job and told how to do it, she says.

3. What are the benefits?

There are benefits to hiring an independent contractor over an employee, according to the SBA. These include less liability, flexibility in hiring and firing the individual, and a savings in labor costs.

An employer can save up to 30 percent with an independent contractor, according to Businessweek Magazine. The savings come with no payroll taxes, unemployment insurance, workers’ compensation and disability, as well as no need to offer pensions, sick days, health insurance or vacation. A business owner also isn’t required to pay a minimum hourly wage or overtime to a contractor.

There also can be less training costs with a contractor. If a business owner hires a contractor who already has the expertise needed to complete the project or job, he or she won’t spend time training the worker.

There can be benefits to hiring employees instead of contractors, as well. Employees usually have more commitment to the business and will be employed long-term. They might put forth more effort because they feel connected to the business. They’ll also be there when the employer has an increase in the company’s workload, whereas a contractor could be booked or unavailable when needed.

Anderson says he doesn’t advise clients one way or the other but encourages them to understand the benefits and disadvantages with both situations including the implications of hiring one type of worker versus another could have on the business’ taxes.

“The smaller the company, the more expensive it is to have an employee,” he says, adding that even if the employee and the contractor work the same number of hours, overtime has to be paid to the employee.

Independent contractors don’t require healthcare insurance, vacation and other benefits, which can save money for the business owner.

“You may be able to do it less expensively with an independent contractor,” Anderson says.

4. What are the negatives?

A business owner must ensure he or she is categorizing an independent contractor correctly, as legal consequences may occur if done incorrectly.

Misrepresenting an employee as an independent contractor can be costly. The employer could be required to reimburse the individual for wages including overtime, pay back taxes and tax penalties, pay workers’ compensation benefits if applicable, and provide the person with health insurance, retirement and other benefits, according to the SBA.

Lull, the Waukee certified public accountant, says she has clients who hire both employees and independent contractors. Many are drawn to the idea of hiring independent contractors.

“They hear it’s better because they don’t have to provide the health insurance or pay the taxes,” she says.

However, she cautions clients that the use of independent contractors is a red flag audit area for the IRS.

The IRS and the U.S. Department of Labor monitor some industries more so than others, and could audit any business it suspects is misusing employees or even at random to inquire about the status of a business’ employees. According to Forbes, this “hit list” includes the construction, nursing, transportation and trucking, security, catering services, cable companies, janitorial services, hotels, landscaping and car service industries.

In recent years, companies such as FedEx, Macy’s, Lowes, Uber and Google have been involved in independent contractor misclassification lawsuits or class action lawsuits that have cost the companies millions of dollars.

A business owner can likely expect to pay more money for a contractor or freelancer. The independent contractor will charge more because their insurance and benefits will be built into their contract rate. However, this might balance out when company benefits are taken into consideration, experts say.

The business owner also can have little control over the contractor, especially if he or she hires additional people to perform parts of the project.

Business owners will sign an independent contract agreement with each person hired. The contract will control all aspects of the employment and may include restrictions on firing the contractor or ownership of the products the contractor produces. Legal experts encourage business owners to thoroughly review any agreement to avoid liability for breach of contract.

Hiring a contractor does not allow for a redundancy in service like an employee offers, McKeen with SPPG says. Her company’s 10 employees work in teams to ensure there is redundancy in service. Each has the skill sets needed to fit the vast majority of the needs of clients, which has minimized the need for contractors.

Independent contractors are used at SPPG once every year or couple of years and not as a way to grow the company. SPPG started in 1984 as a sole proprietorship and has grown as the company expanded its core services. Any sub-contract work is for a niche service that is not a component of the main core services.

The standard advice is to ask yourself these questions and use a checklist to be sure you are proceeding legally and minimizing any risk to your company.

“The purpose of this is you can’t make an employee an independent contractor just by calling them an independent contractor,” Anderson says. ♦