Running Your Business

Contractor Employment vs. Full-Time Employment

  • The IRS strongly regulates whether someone is a contractor or an employee
  • A contractor provides their own equipment, sets their own schedules, pays their own taxes and health insurance, and aren't eligible for unemployment
  • A contractor works for themselves—you're a client, not the boss
Posted by September 6, 2017

When deciding whether to hire someone directly or to offer someone contractor employment, there is more to consider than you might realize. You may think that it’s simply your decision—do you want this person to be a regular “W-2” employee or do you want this person to be a “1099” contractor? The reality is, it’s not all your choice. The IRS strongly regulates whether someone is a contractor or an employee. Here’s what you need to know.

Control Freaks Shouldn’t Hire Contractors

Is it important to you that your contractor works set hours in your office and uses specific tools that you provide? Well, then, you want an employee, not a contractor employee. A contractor needs the freedom to work how they choose. They generally need to provide their own equipment and set their own schedules. You can specify the work that needs to be done, but you don’t get to choose how they do it. If the very idea of an employee with such freedom makes you nervous, remember, a contractor isn’t an employee. That’s the whole point.

Pay and Benefits

Everyone wants great benefits these days, so you might think about offering benefits to your contractors. Good? Nope. Bad. Contractors don’t participate in your health insurance plans, your 401ks, or any other benefit program—outside of Friday’s free lunch. If you provide these benefits, the IRS will say you are an employer, and you’ll have to reclassify the person as an employee, with all the associated costs.

Contractors are responsible for providing their own benefits and the like. They do this by charging higher rates than an employee would see on a paycheck. Remember, when you pay an employee, the cost is not just the end number on their paycheck. You’re paying the employer side of Social Security, plus benefits. When you’re calculating what you’re willing to pay a contractor, you have to consider that they pay for all these things themselves. So, if you pay an employee $25 an hour for a particular job, you’ll probably have to pay a contractor $40-$50 an hour for the same work. That may seem like a really bad deal, but you’re paying just the hourly rate. They pay their own taxes and health insurance, aren’t eligible for unemployment and should provide their own equipment.

Say Goodbye to Exclusivity

A contractor needs to be free to take on other clients. You can require a non-disclosure agreement (NDA) so that they can’t share your business’ confidential information, but you cannot control what other clients they take on. A contractor works for themselves, and you’re a client, not the boss. In fact, you want your contractors to have other clients as it shows the IRS they aren’t your employees.

Easy Hire/Easy Fire

While all states (except Montana) are “at-will” employment states, which means you can terminate an employee for any or no reason as long as it isn’t a violation of law (like firing someone because of race, gender, religion, pregnancy status, etc.), in practice that’s not how it works. You need to ensure that you’ve dotted every I and crossed every T before terminating an employee. You have to prove you followed internal procedures as well as external state, local and federal laws. With a contractor, you can simply say, “I’m not renewing our contract,” and that’s that. It’s purely business.

For some businesses, having a few contractors make sense. For instance, if you can’t afford a full-time HR person, hiring a contractor (or a consultant) to handle your hiring, firing and employee development makes sense. You get expertise for only the amount of time you need. But, if you’re just looking to save money by not having to pay employment taxes and benefits, contractor employment is not the answer.

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