You might be ready to expand your team and I want you to know the distinction between hiring an independent contractor and an employee.
Benefits of Hiring an Independent Contractor
From a business owner’s perspective, (hi business owner over here) you actually have considerable cost savings, increased workforce flexibility by hiring independent contractors, or sometimes as we refer to it, outsourcing. From the perspective of an independent contractor, individuals who choose to become independent contractors probably desire greater control of their work environment and their schedules. Some prefer more variety in their day-to-day work, and more control of the methods they use to accomplish that work, which can be attained through becoming an independent contractor.
While it is advantageous for both parties, independent contractor classifications involve careful consideration of several factors. Applications of multiple standards imposed by federal and state law, and exposure to liability in several areas. The liabilities can include potential liabilities for unpaid overtime compensation, taxes, employee benefits, and of course unemployment.
Simply referring to a worker as an independent contractor even in a written agreement does not prevent these legal challenges to classification by the department of labor, the IRS, or even state and local authorities. Misclassification audits, investigations, and lawsuits are increasingly common as I mentioned, and can result in steep costs and penalties.
Before you sign, I want to identify what an independent contractor is, then share how an employee will serve your business in a different way.
An independent contractor is a worker who contracts with an individual or an entity, who provides services in exchange for compensation on an hourly, monthly, or project basis. They are engaged only for the term they are required to perform or the identified services and retain control over the method and manner of the work. They also retain economic independence, which is significant because they are responsible for paying their income, social security, and Medicare taxes. Last but not least, they are not protected by most federal, state, or local laws that are intended to protect employees. One of which is overtime, or another which we have seen a lot more in 2020 has been unemployment benefits.
A business working with an independent contractor generally has the right to control only the end result of the project, but not how the independent contractor accomplishes it. This doesn’t mean when you hand something off to an independent contractor, that you have no control over the deliverables along the way, or the aesthetics that you cannot give them feedback on. The best practice to know is that you cannot require them to be in your office from 9 to 5 working on a project, and jumping from task to task for your business.
Classification of an Independent Contractor
The most common thing that I hear, is people refer to an independent contractor as a “1099 employee.” What you are doing there is mixing a 1099 independent contractor and a W-2 employee. If they are an independent contractor, refer to them as an independent contractor, a consultant, 1099, but do not refer to them as an employee.
Businesses that engage independent contractors must issue a Form 1099 to businesses that have hired them, which is where we get that “1099” but I don’t why it’s so commonly mixed with “employee.” That 1099 is for income reporting purposes and will be reported to the IRS. You will need this for anyone that you pay compensation for or do a trade of services for a value over $600. The contracting business has no obligation to provide benefits to the independent contractor or withhold or pay employment taxes on the contractor’s behalf. Notice that I said “value” because it counts for trades or giveaways too.
In addition, independent contractors are generally free to offer their services to the public and perform work for other clients. Independent contractors often own their own businesses and provide services according to their terms. However, this does not mean you cannot have a non-compete with an independent contractor, especially if you are using them in a place of trust where they are working with your client’s hand in hand.
An example of this would be a photographer. If you have an independent contractor that you always go to for pictures for your client’s content, you want to make sure there is a non-compete to prevent your independent contractor from competing with you out of the deal. It might sound a little negative, but trust me it happens.
Benefits of Hiring an Employee
Before you have made up your mind about hiring or becoming an independent contractor, let me share with you a few things about what an employee is and what hiring an employee would look like for your business.
An employee, by comparison, is subject to significant oversight by a business. A business has the right to control the method and manner of the employee’s work. In addition, an employee is paid wages which may include overtime compensation depending on their hourly rate, and their overtime would have to be one and half times their regular compensation for any hours worked over 40 hours in a week. There are other business-sponsored benefits that may be part of their total compensation. While these “costs” add up, hiring an employee is an investment!
Quick Tip: If you are hiring employees, make sure that they are aware of the value of their total compensation, because this is a big cost to you and a big benefit to them, and I want them to be aware of how much you are providing for them.
Another piece that we should know about employees is that they are good for a continuous period of time, and perform whatever task a business might require. This gives you, the business owner, the flexibility on the scope of their work, and the liberty to change their role over time.
Classification of an Employee
An employee is also economically dependent on the employer. Their employer is obligated to withhold medicare taxes, social security taxes, and income taxes. Last but definitely not least, an employee is protected by federal, state, and local employment laws. This is back to what we talked about a few times now about overtime compensation, unemployment benefits and to answer one question I hear often is regarding a probationary period. This often has to do with vacation, time, and other benefits, are they subject to potential unemployment, are they subject to withholdings, sick leave, and the answer is yes. From day one of employment, even during a probationary period, those benefits will vest.
How to Formalize Hiring an Employee or Independent Contractor
FOR AN EMPLOYEE: An employee offer letter will help you define what roles the new employee will be taking on, the new expectations for their employees, and all of the details that set expectations for the onboarding process. If you would love to have this in your business, send a quick email to email@example.com and we will make sure you are the first to know, probably with a special discount attached.
FOR AN INDEPENDENT CONTRACTOR: You will want to set expectations in an Agreement. To learn more about how our Independent Contractor Agreement and Virtual Assistant Agreement will be the perfect fit for your business, head on over to our shop.
If you have any questions at all, join us in our private Facebook group where you can share any of your questions and even what you found helpful in this episode.
A final note to you: businesses cannot rely on generalizations to determine the classification of an employee or an independent contractor. The classification relies on the facts in each case, so I encourage you to apply these concepts and the appropriate independent contractor tests in your state to the role you are envisioning.