Contractors vs. Hiring Employees: The Pros and Cons of Both Types of Workers

By on May 19, 2015

Hiring in Small Business

Many small businesses have the need for a flexible workforce. Outsourcing work to independent contractors is a great way to achieve that flexibility, while accessing highly skilled labor that can expand your business. However, as in all things, there are good and bad points in doing so.

Contractor Advantage: Your workforce needs are more easily managed
It’s very common as a small business that you’ll need help in areas like marketing, social media, and other important department, but rarely do small businesses need a full time staff or department for these efforts. That’s where hiring an independent contractor is an excellent alternative. Contractors bring their own expertise to the job and offer flexible pricing and hours to meet your adaptive needs. As a small business that means that you can save the time, cost and energy of hiring, benefits and ongoing staff that you don’t need.

Layoffs or terminations can be stressful not only for the employee being let go, but for you as an employer as well. Contractors eliminate that step by compensating for high-demand times without expecting a permanent position, as well as reducing the need for staff members that aren’t needed full time.

Contractor Advantage: Reduced exposure to lawsuits
Hiring employees comes with the requisite laws and compliance regulations as well. Laws concerning minimum wage, overtime compensation and unlawful termination are all potential exposure risks you take from bad hiring decisions. Hopefully you’ll never be faced with these problems, but it’s important to know that they do exist. Couple those regulations with the benefits packages required by law, payroll taxes, tax withholding regulations and vacation packages and you’ve got a lot of

The employer/contractor relationship is different. Contractors are considered independent businesses, so the relationship is spelled out directly in the contract. They are hired for a specific purpose and for term lengths: when the job is done it’s done and there are many more small business protection clauses that help you if work stipulations outlined in the contract aren’t met by the contractor.

Contractor Advantage: They can save you money
As previously mentioned, there can be high additional costs associated with employees including their benefits and required payroll taxes. Workers’ compensation insurance, Social Security and Medicare taxes, state unemployment compensation insurance and even health care insurance costs are all items that add up on a balance sheet quickly for U.S. based businesses and for many countries, those employee contribution costs are even greater.

With independent contractors, there are no benefits or tax costs to you. Because they are their own business, they are contracted with you to turn out work product strictly for agreed upon compensation, but with no additional benefits required. Any other costs, unless specified in the contract, are borne by the contractor, including being responsible for their own payroll costs.

Contractor Advantage: They provide their own infrastructure

Unless specified in the contract, contractors work out of their own office or home utilizing their own tools and equipment. They are given the project parameters and then they self-manage to complete their work; no office supplies or space are usually needed.

In contrast, employees require orientation, training, regular evaluations and supervision on a daily basis. They also require restrooms, parking spaces and someone to track their hours for accurate paychecks. None of these are required with contractors.

However, there are also drawbacks to using contractors instead of hiring employees.

Contractor Disadvantages: A business with many contractors is more likely to be audited

Government agencies frown on too much use of contractors over employees, because it looks like the business is trying to avoid taxes. The Internal Revenue Service looks at three factors when determining whether someone is a contractor or an employee. One is behavioral control, or whether an employer controls how, when and where a task is to be done; the second is whether a business has financial control over a worker’s job such as work hours, their tools and materials, and their pay schedule.

The last factor is the worker/business owner relationship. If the worker sees the owner as his boss rather than a client, chances are that it is an employer/employee relationship, as independent contractors also work for other clients.

Contractor Disadvantages: Mistakes in classifying employees as contractors can cost money

If the IRS decides you have more of an employee relationship than a contractor relationship with any particular individual, there are a multitude of agencies that will fine and penalize you in the U.S. The Department of Labor, which deals with minimum wage and overtime laws; the IRS, the Occupational Safety and Health Administration and the National Labor Relations Board are all federal agencies that may have questions; state agencies may be involved as well.

Luckily, businesses can check with the IRS if their potential hire is a contractor or an employee under the law ahead of time; either the business or the potential worker can file a Form SS-8, known as a Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding. The form can be downloaded as a PDF from the IRS website at www.irs.gov.

Contractor Disadvantage: They may not be as vested in your success

Independent contractors are hired because they have skill in a specific area, but because they aren’t tied solely to you for their livelihood, there is the chance that they will be less vested in your success than an employee. While this certainly isn’t always the case, it is something you’ll want to monitor throughout the duration of your contractor terms.

To ensure a good outcome, map out in clear terms what you expect the final product to be and establish a clear line of communication for any problems the contractor may have. Make sure that the contract provides for status reports on a regular basis and ensure they’re maintaining their enthusiasm and quality of work.

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Adam Toren

About Adam Toren

Adam Toren is an Award Winning Author, Serial Entrepreneur, and Investor. He Co-Founded YoungEntrepreneur.com along with his brother Matthew. Adam is co-author of the newly released book: Small Business, Big Vision: “Lessons on How to Dominate Your Market from Self-Made Entrepreneurs Who Did it Right” and also co-author of Kidpreneurs.