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Contract worker vs. employee? When you have a new startup or small business, you will come to a resolution that you need some extra help. As a small business owner, you may be considering hiring your first employee or hiring an outside contract worker.
This guide will help you decide between the two for your small business.
Hiring Employees
An employee is an individual who works part-time or full-time under a contract employment, whether oral or written, express or implied, and has recognized rights and duties. Also called worker (BusinessDictionary.com).
The advantages of hiring an employee
Completely control and direct an employee: As an employee of your business, you have the ability to direct the employee's work and duties during work. You have full authority over what the employee can or cannot do.
The disadvantages of hiring an employee
Laws and regulations: Both the federal government and your state government regulate a fair practice of wages or salaries and other work rules. Minimum employment terms and conditions are set down by federal, state, and local laws. Under the Fair Labor Standards Act (FLSA), employers are required to pay covered employees the federal minimum wage and overtime pay for hours worked in excess of 40 hours per week.
To ensure your organization is aware of the latest minimum wage requirements, Paycor has created a breakdown by state.
| State | 2022 Minimum Wage | 2023 Minimum Wage (effective 1/1/23 except as noted) |
|---|---|---|
| Alabama | $7.25 (Federal, no state minimum) | |
| Alaska | $10.34 | |
| Arizona | $12.80 | |
| Arkansas | $11.00 | |
| California | $15.00 for businesses with 26+ employees | $15.00 minimum will apply to all employers Annual increases begin 1/1/23 |
| Colorado | $12.56 | |
| Connecticut | $14.00 | $15.00 effective 6/1/23 |
| Delaware | $10.50 | $11.75 |
| Washington D.C. | $15.20 | |
| Florida | $11.00 | $12.00 effective 9/30/23 |
| Georgia | $5.15 (Employers subject to the Fair Labor Standards Act must pay the $7.25 Federal minimum wage) | |
| Hawaii | $10.10 | |
| Idaho | $7.25 | |
| Illinois | $12.00 | $13.00 |
| Indiana | $7.25 | |
| Iowa | $7.25 | |
| Kansas | $7.25 | |
| Kentucky | $7.25 | |
| Louisiana | $7.25 (Federal, no state minimum) | |
| Maine | $12.75 | |
| Maryland | $12.50 | |
| Massachusetts | $14.25 | $15.00 |
| Michigan | $9.87 | $10.10 |
| Minnesota | $10.33 | Annual increases begin 1/1/23 |
| Mississippi | $7.25 (Federal, no state minimum) | |
| Missouri | $11.15 | $12.00 |
| Montana | $9.20 | Annual increases begin 1/1/23 |
| Nebraska | $9.00 | |
| Nevada | $9.50* | $11.25 |
| New Hampshire | $7.25 (Federal, no state minimum) | |
| New Jersey | $13.00 | $14.00 (Businesses with fewer than 6 employees and seasonal employees pay $12.70) |
| New Mexico | $11.50 | $12.00 |
| New York | $13.20 (fast food– $15.00) | |
| North Carolina | $7.25 (Federal, no state minimum) | |
| North Dakota | $7.25 (Federal, no state minimum) | |
| Ohio | $9.30 | Annual increases begin 1/1/23 |
| Oklahoma | $7.25 | |
| Oregon | $13.50 | Annual increases begin 7/1/23 |
| Pennsylvania | $7.25 (Federal, no state minimum) | |
| Rhode Island | $12.25 | $13.00 |
| South Carolina | $7.25 (Federal, no state minimum) | |
| South Dakota | $9.95 | |
| Tennessee | $7.25 (Federal, no state minimum) | |
| Texas | $7.25 (Federal, no state minimum) | |
| Utah | $7.25 (Federal, no state minimum) | |
| Vermont | $12.55 | Annual increases begin 1/1/23 |
| Virginia | $11.00 | $12.00 |
| Washington | $14.49 | |
| West Virginia | $8.75 | |
| Wisconsin | $7.25 (Federal, no state minimum) | |
| Wyoming | $5.15 (Employers subject to the Fair Labor Standards Act must pay the $7.25 Federal minimum wage) |
An employee hired for your company is also entitled to payroll tax requirements, which includes half of the FICA taxes (Social Security and Medicare) for each employee you have in your company or startup (the other half is covered by them). Other costs can include unemployment insurance and worker's compensation.
If you are considering hiring your first employee, just know that it is not an easy decision. Consider the benefits of bringing in an independent contractor, which doesn't carry much baggage.
Hiring Independent Contractors
An independent contractor is a person or entity contracted to perform work for—or provide services to—another entity as a nonemployee. As a result, independent contractors must pay their own Social Security and Medicare taxes. The payer must correctly classify each payee as either an independent contractor or employee. Another term for an independent contractor is a freelancer (Investopedia).
The advantages of hiring an independent contractor
Lax laws and regulations: You don't much to worry about or tax responsibilities for independent contractors. No matter what type of taxes you file year end, you will have to report the contractors' income paid on a Form 1099-MISC. However, no FICA taxes have to be paid. There aren't any other responsibilities to worry about for a contractor and they can likely get the job done as well as an employee (for significantly less money for you, the employer).
The disadvantages of hiring an independent contractor
No complete control: As an independent contractor of your business, you have the ability to direct the employees' work and duties but they are able to complete them however they please. They also have the ability to take on multiple jobs from many clients, and they set their own hours and use their own tools to get the job done.
Contractors may well have other projects to do or take side gigs like running a BeerMoney blog or find other ways to make passive income online, and may not feel so much like one of the team members. That said, I’ve known contractors who were as much part of the crew as employees. It depends on the individuals as well as their status.
Independent Contractor vs. Employee
Tax responsibilities: If you take on an employee, you must register as an employer as they are entitled to payroll tax requirements, which includes half of the FICA taxes (Social Security and Medicare) for each employee you have in your company or startup (the other half is covered by them). Other costs would include unemployment insurance and worker's compensation.
When you work with a contractor, you don't much to worry about or tax responsibilities for independent contractors.
Paying them: For your employees, their wages will often be their only source of income, so even if business cash flow is tight, you can’t delay or avoid paying them!
With a contractor, you have more flexibility than with an employee to negotiate payment timescales and to pay less than the agreed fees if they don’t cut the mustard. Also, you don't have to worry about providing benefits like whole life insurance or a matching 401K retirement account. But it’s important not to push them too far, or they won’t want to carry on working with you, and your relationship with them will be soured.
Legal: When you take on an employee, you must know your and their rights and responsibilities under employment law, which is a very complex area. For example, you could have to pay statutory sick pay, or maternity or paternity pay. You must give your staff paid time off, and put a contract of employment in place. The list goes on. If you don’t have an HR department, consider using an outsourced HR service to help with this. This is a very easy area to fall into a trap because as the proverb says, “You don’t know what you don’t know.”
A contractor should have a standard contract for services, but again you should be aware of the ins and outs of this and what it would mean for you in the event of a dispute. It might be as well to have the contract checked by a friendly solicitor or legal expert.
Work: You must give your employees work to do, and pay them their full salary even if they have a few tasks to do. For example, in an accountancy practice, the months of June and July are often very quiet, because the key tax filing deadline of April 15th, has passed and the new tax year has not yet begun. Staff in the practice still have to be paid their salaries even if they are not carrying out chargeable client work.
But colleagues who worked as independent contractors often didn’t come in full-time during June and July. You can ask a contractor not to come in, and not pay them if you don’t have any work for them to do.
Development: Relating to the above point, as a good employer you should give your employees regular raises and work with them to help them grow and develop their career path.
Although you should also review your contractors’ performances, their career growth is their own responsibility rather than yours.
Involvement: With all these responsibilities why do business owners take on any employees, rather than simply staffing their business with contractors?
Firstly, because the IRS is on the alert for people avoiding tax by pretending to be independent when they’re actually not, and they will pay that extra tax.
Also, when you’re growing your business it’s important to build the right crew to work together and stay together. When your team is employees who plan to stay with the business long-term, you have the potential to build a much stronger and more effective business. You can take on more capital to build your company and grow even further.
When to Consider Hiring an Employee
You should consider hiring an employee for your business if:
- The work required is long-term and requires your supervision
- You would like to set the workers hours and the tools used by the worker to complete the job
- The job is crucial to the success of your business and the worker is required for the long run
- Your business can sustain minimum wage rates in your states and a levy of taxes that come with hiring an employee
When to Consider Hiring an Independent Contractor
You should consider hiring an independent contractor for your business if:
- You just need a one-off job or project that needs assistance
- The job doesn't require much oversight and can be completed by a freelancer
- The job required at hand is a short-term gig
- The worker required is a professional in their field and doesn't require much involvement from you
- You do not want to worry about withholding FICA taxes and dealing with payroll taxes
The decision to hire a worker as an employee or independent contractor is dependent on what your business requires, but be aware that in the eyes of the IRS, a worker is considered an employee unless proven otherwise. Worker classification is important because it determines if an employer must withhold income taxes and pay Social Security, Medicare taxes and unemployment tax on wages paid to an employee. You need to take into account all the above before deciding on whether to hire an employee or contractor.
Have you hired an independent contractor or your first employee? Let us know your experience in the comments below.
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