When to Use Independent Contractors

I was recently talking with a close friend of mine who runs a small exercise studio, and she mentioned that she was struggling with whether to hire more employees or rely on independent contractors. It turns out this is actually a pretty complex question with a host of financial, legal, and workplace consequences that all small-business owners should be familiar with. So, let’s look at some of the pros and cons of each option.

Advantages of Using Independent Contractors

• They’ll save you money. While the hourly rate that you’ll have to pay an independent contractor is usually higher than the equivalent hourly rate for an employee, your total cost will most likely be lower. That’s because you don’t have to provide contractors with any employee benefits, and you are not required to pay for Social Security or Medicare taxes, state unemployment compensation, or worker’s comp insurance. These expenses can add 30% or more to your total cost to hire an employee, so make sure to factor them in when deciding whom to hire.

• You’ll have more flexibility. Just because you have a small business it doesn’t mean that you only require a small number of specific skills from your employees. But unlike your large competitors you may not be able to afford a full-time workforce that can cover all of the bases. Hiring contractors with specialized skills for finite projects can be a great way to get the help you need when you need it, and to free up that money for other uses when the contractor’s services are no longer required.

• You’re likely to have fewer legal issues. Wrongful termination lawsuits are the most frequent labor suit brought on employers. And since independent contractors cannot file this type of lawsuit, you’ll avoid some potentially costly headaches if a relationship goes sour. Just make sure to structure contractors’ agreements so that your rights to terminate are clearly stated; if you need it, get some help from a lawyer when drawing up the agreements.

Advantages of Hiring Employees

• Increased control. Most independent contractors are independent because they like a certain degree of autonomy and the ability to control their schedules. Interfere with that and you’re likely to have a strained and/or short-lived relationship. Plus, in the view of the IRS one of the differentiating factors between employees and contractors is how much control employers exert over them. If you exert too much, Uncle Sam may tell you that your contractor is actually an employee.

• Greater continuity. A frustration I hear a lot from entrepreneurs is that they’ve found a great contractor, but he or she is often not available when needed. That’s one of the risks you run with contractors and why they are best suited for shorter-term specialized projects. If you have a job that needs to be done day in and day out, you’re probably better off finding someone to fill it on a permanent basis. Consider hiring permanent part-time workers for jobs that are too big for contractors but too small for full-time employees.

• You’re less likely to hear these dreaded words: "Your company is being audited." While you might prefer contractors, the tax authorities definitely prefer employees, because the more folks that are classified as employees, the more money they can collect. There are a whole host of authorities from the IRS to the Department of Labor that can audit your business if they believe you have misclassified your workforce.

So whichever route you choose, make sure that you are familiar with these IRS tips for determining whether your staff classify as independent contractors or employees. If you incorrectly classify someone as an independent contractor, you may be required to pay back taxes and penalties and to provide him or her with employee benefits.

Next: Setting Salary for New Hires