Hiring Employees Vs Contractors For Your Small Business – The Ultimate Small Business Startup Guide Part 5
This is part 5 of a 7 part guide on how to start a small business.
Given enough time and hard work, your business will eventually take off and you’ll find yourself needing additional help in order to expand. If you are looking to hire your own workforce, there are many things you need to consider. For starters, there are 2 basic types of help that you can hire, employees and contractors. And ultimately, the type of workers you choose to hire can have far reaching implications for your small business.
Small Business Startup Guide
Hiring Help Is Not That Straightforward.
This portion of the guide will help to define the difference between contractors and employees along with the headaches associated with hiring each type. The main thing to keep in mind is that if you don’t do things by the book, you could be in for a world of hurt if the government ever finds out.
The Difference Between Contractors and Employees
The main difference between contractors and employees is that contractors are in business for themselves. Therefore, when you hire a contractor to help you out, you are essentially paying them to perform a specific service for you on their own time using their own resources. They are also responsible for declaring taxes on their own personal income. In short, when hiring a contractor, the paperwork burden is on the contractor and not on your business.
On the other hand if you hire your own employee, you are responsible for taking care of and paying a bunch of taxes. In addition, there’s a ton of paperwork involved that needs to be filed with the government on a regular basis.
Why Don’t I Just Stick With Contractors And Avoid The Hassle?
Does hiring a contractor sound more favorable to you? In almost all cases, it’s much easier to hire a contractor than an employee especially if you are running a small business. But what’s the catch? Why not always hire contractors and avoid all of the paperwork? The catch is that there are many important distinctions and rules that must be followed when classifying a worker as a contractor or employee. If you are ever caught treating a contractor like an employee, you can be punished by the IRS big time.
Just as a side note, hiring a contractor versus an employee is something that my wife and I struggled with for a long time with our online wedding linens business. It can be extremely complicated to hire your first employee, but once you get past all of the red tape with your first employee, the incremental cost of hiring another one is very small.
That being said, if you can find independent contractors to do the work for you, there’s really no reason to hire your own employee. Hiring your own employee usually makes sense if the nature of the work is unique or special to your company. It’s also nice to be able to bring up and train a worker to do things your way using your own methodologies. In the end though, it’s a tradeoff between additional cost and headaches versus control. You have to make the call.
When Is A Worker Considered A Contractor?
You can safely classify a worker you hire as a contractor if…
- The worker has his/her own tools to do the job
- The worker has his own office or place of business
- The worker does work for several other clients as well
- The workers does the work on his/her own time and sets the hours
When Is A Worker Considered An Employee?
You should classify a worker as an employee if…
- The worker works for you and only you
- The worker works a number of hours that you set.
- The worker uses your equipment to do the job
- The worker gives orders or supervises any of your employees
What If It’s Ambiguous?
In many cases, a worker you hire might fall somewhere in between a contractor and an employee. Ultimately, you need to make the call but keep in mind that the penalties can be quite stiff if you ever make the wrong distinction.
For example, if you ever need to fire one of your contractors that you’ve been treating as an employee, they could technically demand to be paid unemployment by the government. If the government finds that you erroneously classified your employee as a contractor, then the IRS could force you to pay back any back taxes along with stiff penalties. In general, if you are unsure, you should always classify your workers as employees. In any case, it’s usually best to consult an expert on the matter.
How Do I Hire An Employee?
Unfortunately, it’s a major pain in the butt to hire your first employee. Just as a reference, I’ve outlined all of the major steps involved below. As you will see, there are a lot of things that you will need to do. What I especially hate about the entire process is that you have to file paperwork with several different agencies in addition to the government. Now why the heck would a country that was built upon capitalism and entrepreneurship make it such a hassle is beyond me and probably a good topic for a different post.
Are you ready? Here’s a general idea of what is required to hire your first employee.
- You must obtain workers compensation insurance and notify the employee of their worker’s compensation rights. Fortunately, worker’s comp insurance isn’t that expensive but can get pricey depending on the nature of your business.
- Within 20 days of your employee’s first day at work, you must file a report to the Employment Development Department or EDD for short.
- You must start performing payroll and paying payroll taxes. This includes withholding state and federal income taxes from employee paychecks. You also must report these wages and withholdings to the IRS using a W-2.
- You have to register and pay for unemployment insurance at the state level. Ever wonder how unemployment benefits are funded? Now you know.
- You have to withhold employee contributions to your state’s disability program.
- You must pay unemployment taxes at the federal level as well. This is a tax that you have to pay directly instead of taking it out of your employee’s paycheck.
- You must pay the employer’s portion of Social Security and Medicare taxes for each employee based on your employee’s wages
- You have to make sure that your office complies with state and federal safety laws set forth by OSHA. Basically, you have to have an injury prevention plan and more or less keep track of all injuries at the office.
Is It Worth The Hassle?
The bottom line is that hiring your first employee is a huge step and requires a ton of paperwork and regulation. Handling payroll is no easy task either. To make things smoother, I strongly recommend that you contract out your payroll to a 3rd party. They will handle all of the paperwork and necessary filings and all you have to do is tell them who to pay and how much.
In any case, I also recommend trying to stick with contractors for as long as you can. As long as no specialized work needs to be done for your small business, there’s really no pressing need to take on the burden of having an employee. Of course, only you can be the judge. Once you hire your first employee though, it’s a cake walk to add on additional staff.
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- The Ultimate Small Business Startup Guide – Introduction
- Small Business Resources And Where To Find Help- The Ultimate Small Business Startup Guide Part 7
- Growing Pains That We Are Experiencing With Our Online Business
- The Ultimate Small Business Startup Guide
- Small Business Requirements And Permits – The Ultimate Small Business Startup Guide Part 3