Employees or Contractors – Which Way is the Right Way?

Congratulations on taking the next step to grow your business … bringing in help!  Making the choice to hire an employee or a contractor is something that requires a good deal of thought. It might not seem like it, but this is a big decision and one that can significantly impact your business now and well into the future.

Hiring a contractor is easy.  Why not hire all contractors and save yourself the added responsibility that come with hiring employees – like getting a tax id, paying for worker’s compensation insurance, filing and paying payroll taxes, and paying for employee benefits.  Don’t forget all of that employee paperwork that has to be signed, and all within a legal timeframe. 

While it may seem tempting to just hire an independent contractor, I would like to caution you to reconsider that thought.  With ever increasing regulations and restrictions on what distinguishes a contractor from an employee, failing to consider these guidelines and treating a contractor like an employee can result in some serious penalties, including retroactive penalties that you, the business owner, would have to pay if an audit resulted in a reclassification of a worker. 

There are some obvious differences between classifying a worker as a contractor or as an employee.  There are several factors to consider in determining the right classification.  Here are just a few:

Control over hours worked A Contractor sets their own hours and works on their schedule.  An employee reports to work at a time that is set by the employer and works on a schedule set by the employer.

Ability to accept other work A Contractor may work for multiple clients.  An employee generally works only for the employer. 

Provision of materials and equipment Contractors provide their own tools and equipment to complete the job.  An employee uses your tools and equipment to complete the job.

Length of WorkContractors generally work for a specified period of time (two weeks, 30 days, 6 months, etc).  While they may be subject to at-will agreements, employees generally have an understanding that they have a continuous work arrangement.

Other factors are – skill level required, nature of the work, and the level of control over the work.

The IRS uses a 20-factor common law test to determine the level of control an employer has over a worker.  The reasonable basis test is a ‘safe harbor’.  The IRS looks at how similar workers have been classified within your company or industry in the past. 

The possibility of being audited and being required to reclassify an independent contractor to an employee is very real.  One thing is for sure, the IRS is not looking to reclassify employees to an independent contractor status.  You’ve worked hard to build your business and getting caught for misclassifying a contractor to avoid payroll taxes can cost your business big time … not only in penalties, but interest and back taxes.  Taking the easy way is not always the right way.