Employees vs. Contractors: What’s the Difference?

Picture this: You’re a successful small business owner with a growing venture. You’ve reached the point where you simply can no longer handle everything on your to-do list each day. You’re now ready to hire some help. But should you hire talent as employees? Or, should you make your team members independent contractors? It’s a question you should spend plenty of time thinking about to come up with the most appropriate answer for your business.

What Are Employees?

An employee is an individual who provides a specified set of services to an employer. For example, a customer service agent for an insurance company may be an employee. Or, the cook at your favorite restaurant may also be considered an employee of the eatery.

The primary tax concept of an employee is that an employer must withhold taxes from an employee’s paychecks. These taxes help cover Social Security and Medicare taxes, along with unemployment taxes. Employees receive a copy of Form W-2 as a pay stub or direct-deposit payment, which indicates the taxes that have been withheld.

You can have either part-time or full-time employees. This depends on the number of hours someone works each week or each pay period. Employers routinely define the number as between 35 and 40 hours per week for an employee to qualify for full-time status.

An employer can offer employees benefits, including health insurance, paid vacation time, a 401(k) retirement plan, tuition reimbursement, and other nice perks. In most cases, money is withheld from an employee’s paycheck to cover certain benefits.

Finally, employees are required to follow an employer’s rules. This could mean using a time clock to work certain hours or reporting to work at odd hours for special circumstances. It could also involve following a dress code and using a company’s equipment, such as a company-provided laptop or vehicle.

What Are Independent Contractors?

The word “independent” in the term independent contractor is there for a reason. A contractor often works as an independent individual of a company. As such, contractors may be hired on an as-needed, freelance basis. An Uber driver or a marketing consultant are two examples of contractors who are not formally employed by the companies – or clients – for which they work.

In terms of taxes, an employer does not withhold taxes from a contractor’s paycheck. Instead, the employer gives the contractor a copy of Form 1099-MISC, which reports all income paid to the contract worker. The contractor is then required to report this income on his or her personal income tax return when filing it with the IRS. Additionally, the contractor must pay self-employment taxes, which include Social Security and Medicare taxes. The contractor may also owe estimated tax payments to the IRS throughout the year. The bottom line is that independent contractors are responsible for paying all required taxes, unlike employees who have taxes withheld from their income by an employer.

Also, an employer is not obligated to provide any types of benefits to an independent contractor. In fact, a contractor may have to bring his or her personal computer to an office to perform a specific task. On the flipside, contractors are usually free to do their own thing without having to follow any specific rules within a company that employees must abide by. Contractors are also on the hook for purchasing their own health insurance, setting up their own retirement plans, and allotting for their own unpaid vacation time.

Should I Hire Employees Or Contractors?

Like snowflakes, small business owners are all unique. Therefore, their business structures and circumstances vary. Consider asking yourself these questions to help you answer the $64,000 question of deciding between hiring employees vs. contractors:

• How many workers do I need right now?
• How much time will it take a worker to complete a task?
• Can I afford office space to house a team of employees?
• Can I hire remote workers?
• Do others in my industry hire employees or contractors more often?
• Can I afford to pay my workers’ health insurance?
• Do I have short-term or long-term needs?
• Is my payroll system up to snuff?

Remember that just because one small business owner hires employees doesn’t mean you’re obligated to do so. Evaluate your needs and make a wise decision. Of course, you can always hire contractors at first and determine if you could make them employees at some point in the future. In most instances, however, it is much more desirable for a small business owner to hire contractors due to the numerous perks of not having to file payroll taxes or withhold taxes from these individuals’ paychecks. In essence, it makes life a lot easier for the employer in terms of the logistics involved in running a successful business.