Employees vs. Contractors: the Differences go Beyond Taxes
Most small business owners outgrow handling every facet of their business themselves. When that happens to you, if it hasn’t already, expanding your team is the logical next step. But, deciding to expand is only half the battle. You also need to choose how you want to grow your organization. Is hiring a W2 employee the right call? Or would a 1099 contractor be more appropriate? If you’re a small business owner in this position, you’ve probably fallen down more than one research rabbit hole trying to determine if contractors or employees are right for you.
There are a lot of great resources out there that dive deep into the financial implications of each choice. Which is fantastic, because the financial impacts of hiring employees vs. using contractors should be a major factor in your decision-making process. It is not, however, the only factor. Deciding how to expand your team will have long-term effects that go far beyond your organization’s bottom line, and looking at this choice solely from the perspective of how to mitigate risk and/or keep the IRS happy is shortsighted.
Let’s talk contractors.
I’m not going to get into the weeds and discuss the legal definition of a contractor beyond mentioning that at this time there is a federal definition of a contractor. Some states are considering making changes to the federal definition, and you need to be aware of your state’s regulations before you start working with contractors. Take some time to research the relevant regulations before inadvertently running foul of your state’s labor laws. This is one of those times when talking with an expert is worth the time and expense, and you should discuss your situation with an HR professional or a lawyer before making your final decision. But, even with the complicated regulations surrounding contractors, many small business owners turn to them as their business grows.
Why choose contractors?
It makes sense, especially if you’re concerned about your ability to afford a permanent employee. If you use 1099 contractors, you don’t have to worry about payroll, taxes, or long-term commitments. Ideally, contractors are easier for you to manage. They do their thing, complete their tasks, and that’s that. Your job is to manage the product, not the people. In fact, you are legally limited in how much you can manage your contractors at all. You can give a deadline, but you can’t dictate when work occurs. In reality, you will probably still be managing the people, to some extent. But it shouldn’t be as much effort as managing employees.
What are the downsides?
Contractors aren’t as committed to your organization as employees would be. In general, they are performing the same tasks for other organizations, and your company is just one of their daily tasks. While you don’t owe them long-term commitment, they don’t owe you any commitment either (beyond the terms of the contract, obviously). Furthermore, you are legally prohibited from giving your contractors performance reviews — potentially limiting their long term growth.
Don’t underestimate the importance of security when it comes to motivating your team. In many cases, if a contractor feels that they will have more security elsewhere, they will move on. This brings up the major downside of relying solely on contractors: you immediately limit your talent pool to candidates that can accept the risk that comes with contracting. In a country that links employment and health insurance, you’re limiting yourself to people that either A) have a spouse that carries insurance, B) are young enough to still be on their parents’ insurance, or C) are wealthy enough to not worry too much about insurance.
Let’s talk employees.
From a legal perspective, employees are just so much easier. The IRS loves employees, and would really prefer that everyone use them all the time. If you’re worried about taxes and upsetting the IRS, employees are the way to go. However, while hiring employees might make the IRS happy, they can be riskier from a business perspective.
Why choose employees?
If you need a team member to perform duties that a contractor legally can’t, then an employee is your only option. So, once again, please talk to an expert to make sure you stay on the right side of the law. Fortunately, the benefits of hiring an employee go far beyond simply keeping things legal. While employees don’t stay with organizations forever, they are committed in a way that contractors aren’t. Employee buy-in and stability are major contributors to long-term growth.
From a motivational perspective, people feel differently about being an employee than they do about being a contractor. As employees, they are part of a team — not cogs in a machine. Plus, since your organization likely supplies benefits (including insurance) that your employees rely on, your organization’s long-term success matters to them in a way that it doesn’t to contractors.
What are the downsides?
All that commitment we just talked about? It creates risk for the employer. You will be responsible for payroll, taxes, and benefits — possibly straining your organization’s resources. You’ll need to figure out a way to pay your employees or let them go if you genuinely can’t afford them. You can’t just tell your employees, “Sorry, I don’t have any work for you this month” when things get tight and expect them to cheerfully rejoin your team when business picks back up.
Which option is right for you?
It depends. This choice generates debate because neither is a perfect solution. If you are looking for long-term growth, in my experience, employees are much better options. However, if your work is very contract-based — or if you need help in a targeted business-support role — then contractors are an awesome solution. A good virtual assistant, social media manager, or bookkeeper will free up some time, and allow you to focus your attention on revenue-generating tasks.
Deciding how to grow your team is one of the more important and complex choices you’ll make as a small business owner. Doing your own research is a great start, but you’ll probably want to talk to an expert before making any decisions. The HR professionals at Office Accomplice can guide you as you navigate the contractor vs. employee decision-making process, and will help make building your team a seamless transition. Reach out to see how our HR experts can support your organization as it grows.
