SCORE Minnesota

Independent Contractors vs Employees

February 15, 2010

While it is true that employees can be one of a business’s greatest assets they can also be one of its greatest liabilities. In most businesses payroll costs represent a significant percentage of the operating budget. Over and above the cost of employee compensation employers are responsible for many other costs such as taxes, insurance, benefits, training, and administration fees that they don’t have with independent contractors.

Independent contractors can allow a business to meet certain objectives without the typical burdens and costs associated with having employees. This is why independent contractors can be an especially attractive option for small businesses that don’t have the resources or the need for full-time employees.  In fact, some small businesses essentially serve as independent contractors to other enterprises. However, the IRS and equivalent state agencies can impose heavy fines and/or penalties on a business that has independent contractors who technically should be given employee status.

So, before you hire one or more independent contractors, make sure that your relationship fits entirely within the IRS’s definition of contract labor, and that both you and your contractors understand the rights and responsibilities of everyone involved.

Deciding who can legitimately work as an independent contractor and who must be given employee status has become a difficult matter for small business owners. You can’t simply choose what’s best for you.

Remember that independent contractors work for themselves. They operate their own business. In a relationship between you and your independent contractor (s), you are the client, not the employer. You can’t dictate the hours that independent contractors work. Nor can you control how they perform their work. However, according to most government agencies, workers are employees unless you can prove otherwise.

Independent contractors are in control of when, where, and how much they work. You should refrain from dictating daily or weekly work hours. Also, independent contractors do not usually have a permanent or continuing relationship with the business. They usually have time to pursue other clients. It is best to compensate independent contractors on a per-project basis, not weekly or monthly.

Since independent contractors are paid to complete a set task, they may bring in others to help, at their discretion, and on their payroll. They should also use their own tools and technology and be responsible for their incremental expenses.

Contractors can’t be fired as long as they produce results that meet their contract specifications. You should not cover independent contractors under any insurance or benefits that you offer to employees. Independent contractors are subject to making a profit—or suffering a loss—based on their own skills and expertise. Always require an invoice before making payment.

When determining whether or not you should use independent contractors or hire employees, you should consider the following questions:

• Is the work you need performed in response to a temporary need, a one-off initiative or project, or is it a requirement for the ongoing operation of your business? If you anticipate an ongoing need for this type of work in your business you may be better off hiring an employee rather than an independent contractor who may not always be available.

• Will the work you need performed give workers access to confidential information or company assets such as clients/customers or trade secrets?  If so, you may be better off hiring an employee as it is easier to foster loyalty. Make sure, however, that these employees sign non-compete agreements. If you opt to use independent contractors, be sure to have them sign non-disclosure agreements.

If you understand the requirements of using independent contractors it will help you determine whether such relationships are right for your current business needs, or if you are better off hiring employees. Make sure your independent contractors understand the rights and responsibilities involved as well. Well written Independent Contractor Agreements should spell out these issues clearly and can go a long ways to prevent potentially costly disputes.

To learn more success-minded ideas for your small business, contact SCORE by clicking the link on the right to the office nearest you or click here to request free face to face counseling.

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Susan Fronk, St. Paul SCORE
View more posts by Susan Fronk

Filed under: Human Resources, Management

Tags: cost of employees vs. independent contractors, IRS requirements, responsiblities of independent contractors