1099 Tax Software Blog

For business owners, there is going to be the inevitable dilemma on the choice of whether or not they wish to hire independent contractors or employees as workers. Not only is the determination of whether a worker is an employee or contractor a sometimes complicated choice, but the tax and other benefits and disadvantages of the two types of workers is another detailed issue. This article will go into detail on some of the advantages and disadvantages of hiring an employee over a contractor from an employer’s perspective.

First, if you are looking to hire an employee, it should be noted that there are differences between part and full time employees. Without going into too much detail on this difference, which requires much length to explain, part time employees are generally cheaper to hire because they do not require certain benefits, and they are often helpful if your business is seasonal.

A disadvantage of hiring an employee is increased payroll costs. The law requires you to pay your employees a share of their Social Security and Medicare taxes. Also, state unemployment insurance and workers’ compensation insurances are required to be paid by you as the employer. Together, these taxes and insurances can increase your payroll costs from 15-35%.

An advantage of hiring an employee is that you will almost complete control over when, where, and how the worker does his or her job. This can be quite advantageous, especially when independent contractors are not trained in very specialized needs for your business. More control over your employees also allows you to assign them to a wide variety of tasks that they can be trained in, whereas contractors are often hired for just one specific task that they specialize in.

Employees have several legal rights, and as a result you have more of a chance of being sued by an employee than an independent contractor. Although workers’ compensation covers many types of on the job physical injuries, there are other lawsuits which may be filed including any type of discrimination, harassment from other workers while at work, and other lawsuits.

However, an added benefit is that employees are loyal to your business alone. You will not need to worry about the competition for skilled independent contractors that often requires businesses to pay much more per hour to them than an employee. Also, employees may be more motivated by the potential for promotions and may show more commitment to the business because they are a part of the team.

Also, hiring independent contractors for a large variety of tasks can be quite time consuming. There is always the issue of arranging contracts, communicating your project needs to the contractor, and sometimes contractors are quite difficult to control. A physically present employee is generally willing to perform tasks immediately, there is no need to waste time preparing a contract for each and every task that the employee would perform, and communication with employees is much more convenient and easier than independent contractors.

These are a just few of the benefits and disadvantages of hiring an employee. Ultimately, the choice of hiring mostly independent contractors or employees is a complicated one, and for particular businesses having mostly employees as workers is efficient and for other businesses it is not.

The common-law-rules as defined by the IRS can help business owners determine whether their workers are considered employees or contractors. It is crucial for business owners to make this determination because each classification is subject to different tax withholdings and laws.

A business owner may do this by considering the degree of control over the worker, and also the nature of the relationship with the worker. The IRS defines this by three categories: behavioral control, financial control, and the type of relationship between the business and worker.

Behavioral control refers to how much the business owner controls how the worker does his or her job. Behavioral control is further classified by the IRS by four categories:

1.) Type of Instructions Given – Does the business mostly determine when, where, and how to work? Contractors have a greater degree of control over these details.

2.) Degree of Instruction – In general, the more detailed and elaborate the instructions are that the business gives the worker, the greater the chance that the worker is an employee.

3.) Evaluation System – If there is some kind of ongoing job or work evaluation system, the worker is likely an employee.

4.) Training – If there is detailed job training, it points to the fact that the business owner wants the job done in a very specific way. Also, if there is continual training during the worker’s tenure, then the worker is likely an employee.

Financial control refers to how much the business owner controls all of the financial circumstances of a worker’s job. This control falls into five categories:

1.) Significant Investment – Does the worker purchase his or her own equipment? Generally, independent contractors purchase their own equipment.

2.) Unreimbursed Expenses – Independent contractors have more unreimbursed expenses than employees.

3.) Opportunity for Profit or Loss – Independent contractors have a greater potential to lose money on their contracts. For example, the cost of equipment for a job might be more than the contractor’s earnings for that job.

4.) Services Available to the Market – An independent contractor is allowed to have his or her own individual freedom to market their business or service. Many employees are not.

5.) Method of Payment – Many employees are paid hourly and guaranteed a specific wage per hour. Independent contractors can be paid hourly or with a flat fee.

Type of relationship refers to the details on the perception of the relationship between the business and worker. The categories that determine type of relationship are as follows:

1.) Written Contracts – Even though a contract may state whether a worker is an employee or contractor, the IRS is not obligated to agree with this classification.

2.) Employee Benefits – Employees are more likely to have benefits like paid vacation, sick leave, health insurance, and others.

3.) Permanency of the Relationship – Employees are more likely to be hired on an indefinite basis, whereas independent contractors are generally hired for fixed terms.

4.) Services Provided as a Key Activity of the Business – Employees that provide services such as consulting or advice are still mostly under the control of their employers.

With these common-law-rules, businesses can make a reasonable guess to what their workers are classified as. Again, if there is any question, the IRS will make the official classification from form SS-8.