If your company is in need of a new hire, you can choose to hire an employee or a contractor. Both of these roles have different benefits, costs, and tax implications. To understand what these differences are, you should first know how the contractor position varies from a standard employee. The option that’s best for your business largely depends on your current needs and if these needs require a permanent or temporary hire. In this guide, you’ll be provided with a detailed comparison between contractors and employees.
How Is Someone a Contractor?
A contractor is a person who is doing business for themselves, which means that the contractor will promote their services and the benefits that come with hiring them. A contractor doesn’t work for another company on a permanent basis. Based on guidelines set by the IRS, someone can be an independent contractor in the event that the payer can direct or control the result of the work but not how the work is done.
In most cases, contractors will work for businesses temporarily with a stated end to their services. Some contractors offer their services on an as-needed basis for however long the company requires. Employees differ since they are hired by a company with no actual end-date. They remain at the company until they decide to leave or are let go.
Tax Requirements for Contractors and Employees
The tax requirements for employees and contractors differ substantially. If your business hires an employee, you must withhold a certain portion of their wages that will be used for income taxes as well as employment taxes. You’ll also need to remit these withholdings directly to the government. A small percentage of the employee’s employment taxes will also need to be paid by your company.
As for independent contractors, your business won’t be directly responsible for any taxes they’re required to pay. All you need to do is file the standard IRS Form 1099. The information you place on this form will be gathered by the IRS to ensure that the contractor in question pays all of the taxes they owe. When looking specifically at taxes, hiring a contractor means considerably less work for you as well as a lower investment.
However, many companies make the mistake of incorrectly classifying their employees as independent contractors to get out of paying employee taxes. States like Maryland have placed strict sanctions on this issue, which could cost companies a large sum of money if they are found to have intentionally misclassified employees as contractors.
In Maryland, employers who don’t correctly classify workers as employees will be tasked with paying delinquent unemployment contributions. In the event that the employer doesn’t pay this assessment in 45 days, they will be charged a 2% interest for every month until the payment is made.
It’s also possible for the employer to be given a civil penalty that amounts to as much as $5,000 for every employee who was incorrectly classified. When a company is a repeat offender, the penalty can increase to as much as $10,000.
Why You Should Avoid Misclassification
Keep in mind that Maryland isn’t the only state that will allot fines and penalties to companies that incorrectly classify their employees. The same is true with the Internal Revenue Service. When the IRS finds that a company has incorrectly classified an employee as an independent contractor, they could assign high penalties to the employer in question.
These penalties include a $50 fine for all W-2 forms that weren’t properly filed, as much as 40% of FICA taxes that weren’t correctly withheld, up to 100% of matching FICA taxes that the employer is required to pay, and as much as 3% of wages. Your company can avoid these penalties by correctly classifying employees and contractors. Otherwise, you will invariably lose a large amount of money.
Benefits of Hiring a Contractor vs. Employees
There are tangible benefits that come with hiring contractors and employees. When you hire a contractor, you’ll be able to save money. Even though independent contractors usually earn a higher amount of money when compared to employees, hiring employees means that you’ll need to pay more for taxes, office space, and employee benefits to accommodate each employee.
Hiring contractors also offers greater flexibility. For instance, it’s possible to hire a contractor for a specific project. After this project has been completed, the contractor can be dismissed per their contract. Keep in mind that there’s a competitive advantage that comes with hiring a contractor as opposed to an employee. A higher number of skilled employees enjoy the flexibility that comes with contract work, which means that businesses are able to benefit from an expansive talent pool to stay competitive.
Another benefit of hiring contractors is that you’ll have less liability. An an employer, there are several laws that protect employees you hire, which include everything from having a safe work environment to protection from unjustified termination. When you hire an independent contractor, you’ll have greater control over when the contractor is hired and let go, which reduces your liability.
There are also some clear advantages afforded by the employee-employer relationship, the primary of which is company loyalty. Employees generally have a better sense of loyalty to their employer when compared to contractors. If your business hires employees that receive full-time benefits, this indicates that you have total confidence in these employees and are looking to invest in their development and growth.
Hiring employees also helps to streamline training. Even though independent contractor tend to require less training when compared to full-time employees, you might invest more time with training if there’s regular turnover when it comes to short-term contractors.
The employees you hire can be great brand ambassadors as well. In most cases, independent contractors only support the company they work for in a manner that allows them to promote themselves. As for employees, their career trajectory can improve by helping the company they work for develop and grow.
Cost of Hiring Employees vs. Contractors
Before you decide to hire contractors or employees, you should understand the difference in costs associated with these positions. The employer costs for employee compensation averaged around $41 per hour in June 2022.
Salary and wage costs average a little more than $28, which accounted for 69% of costs. Benefit expenses were around $12.72, which made up the other 31% of the employee cost. When looking at each type of benefit that employers pay for, it’s been found that benefits for private industry employees amounted to $1.33 per hour for savings and retirement. Insurance benefits were $2.96 per hour.
Hiring a contractor allows you to obtain savings of around 31% since you won’t need to pay for unemployment insurance, benefits, workers’ compensation, and payroll taxes. Benefits like sick days, vacation time, pensions, and health insurance are unnecessary when you hire independent contractors. Since contractors are self-employed, they are tasked with paying 15.3% for Medicare and Social Security.
Now that it’s time to determine if you should hire a temporary independent contractor or an employee, all of the factors mentioned previously should be taken into account. Do you want to save money? If so, hiring independent contractors can be highly beneficial. If you want workers who have a certain amount of loyalty to your business, it might be best to hire employees.