Independent Contractor vs. Employee: Who Should I Hire?

Aug 28, 2024 Angie Wood, CPA No Comments 110 Views Share on

As a business owner in the post-COVID era, you’ve probably wondered if you should hire an independent contractor instead of an employee. After all, there are lots of independent contractors and freelance workers out there these days! And it may seem like an easy way to bring on talent, without all the paperwork and extra costs of hiring in-house. 

However, the “employee or contractor” question isn’t so easily answered. There are a series of considerations that can help determine your best choice. 

At Wood CPA, we’ve guided many clients through this decision-making process of hiring contractors vs employees. Today, we’re going to share our insights on worker classifications, the tax implications of each, and how to choose the right person for the job.

Key Takeaways:

• The classification of workers as employees vs contractors is not a choice for an employer to make, but is determined by specific IRS rules
• Misclassifying workers can result in significant penalties and back taxes
• There are advantages of both independent contractors and employees, depending on your business needs

A CPA can help you navigate the decision-making process and ensure compliance with IRS rules on independent contractor vs employee classification.

It’s Not Your Call: Understanding Worker Classification

One of the most common misconceptions I encounter as a CPA is that business owners can choose whether to classify a worker as an employee or a 1099 contractor. This simply isn’t the case. 

The IRS actually has specific criteria that determine how a worker should be classified. There are three main categories to help determine employed worker vs contractor status:

1. Behavioral Control: Does your company control or have the right to control what the worker does and how the worker does their job?
2. Financial Control: Does the business direct or control the financial and business aspects of the worker’s job?
3. Type of Relationship: Are there written contracts or employee-type benefits? Will the relationship continue and is the work a key aspect of the business?

The above questions will help you determine the degree of your company’s control over a worker, and their level of independence. The more control you have over a person, the more likely it is that they should be classified as an employee. The more independent a worker is, the more likely they should be classified as an independent contractor. 

It’s important to understand these criteria because misclassifying workers can lead to significant consequences. You can also find the IRS’s full 20-point checklist for determining classification here. 

The Tax Implications: Employees vs. Contractors

When it comes to taxes, there are notable differences between hiring employees and engaging independent contractors.

For Employees:

• You’ll need to withhold income taxes, withhold and pay Social Security and Medicare taxes, and pay unemployment tax on wages.
• You’ll need to provide your employees with a W-2 form at the end of the year.
• You may need to provide benefits, which can be tax-deductible for your business.

For Independent Contractors:

• You don’t withhold taxes. The contractor is responsible for paying their own income tax and self-employment tax.
• You’ll need to provide a 1099-NEC form at the end of the year if you pay them $600 or more.
• You don’t pay unemployment tax for independent contractors.

While it might seem that hiring independent contractors results in less paperwork and lower costs, remember: it’s not about choosing the option that’s most convenient for your business. It’s about correctly classifying workers based on the nature of their work and your relationship with them.

Penalties for Misclassification

Misclassifying employees as independent contractors might seem tempting as a way to save on taxes and benefits, but the consequences can be severe. If the IRS determines that you’ve misclassified workers, you could be on the hook for:

• Back payroll taxes
• Penalties and interest
• Unpaid unemployment insurance
• Potential lawsuits from misclassified workers

Moral of the story, make sure your workers are classified correctly — it will save you time and money in the long run!

When to Hire an Independent Contractor 

While the decision isn’t entirely up to you, there are situations where engaging an independent contractor might be more appropriate:

1. For specialized, short-term projects
2. When you need flexibility in workforce size
3. For roles that require minimal oversight and control from your business
4. When the work is not a core function of your business

For example, as a small business owner myself, I chose to hire a marketing contractor rather than a full-time employee when I needed help with my marketing efforts. This allowed me to get the expertise I needed without committing to a full-time salary and benefits. 

As this was a specialized project that isn’t a core function of my business, it was the perfect role for an independent contractor.

When to Consider Hiring an Employee

On the other hand, hiring an employee might be more suitable when:

1. The role is central to your business
2. You need to have significant control over how and when the work is done
3. You’re looking for a long-term commitment
4. You want to invest in training and developing the individual

Remember, as your business grows and scales, hiring employees becomes necessary to build a cohesive team aligned with your business mission.

Can Part-Time Employees and Remote Workers be Contractors?

While you can certainly hire an independent contractor to work “part-time” (under 40 hours a week), part-time employees are still considered employees under IRS rules. They’re still subject to the same tax withholding and labor laws as full-time employees. A part-time employee vs contractor distinction isn’t about the number of hours worked, but about the nature of the work relationship.

Remote workers can either be employees or independent contractors, depending on the nature of their relationship with the employer. The same IRS rules on independent contractor vs employee status apply, regardless of work location.

Recent Changes in Worker Classification Laws

It’s important to note that worker classification laws can change. For example, Minnesota recently introduced stricter laws for classifying workers, particularly in the construction industry. These changes expanded the criteria for determining worker status from three main points to 14.

While these changes are specific to Minnesota and the construction industry, they show how important it is to stay informed about worker classification laws in your state and industry.

How a CPA Can Help

If you’re unsure about how to classify your workers, or if you need help deciding what type of worker is appropriate for the jobs you’re hiring for, a CPA can help. Our job is to make sure your taxes are filed accurately, and that includes payroll taxes. 

At Wood CPA, we assist you by:

1. Analyzing your situation to determine the correct classification for your workers
2. Helping you understand the tax implications of your hiring decisions
3. Assisting with payroll setup and tax reporting for employees
4. Providing W2s and 1099 forms to your employees and independent contractors 
5. Keeping you informed about changes in tax laws and regulations that might affect your hiring decisions

Let Wood CPA Keep You in Compliance 

Remember, when it comes to 1099 contractor vs employee classification, it’s important that you do things by the book. At Wood CPA, we can help you make informed hiring decisions that keep your business compliant and thriving. 

Interested in becoming a client? Contact us today to schedule a consultation. We’ve got the expertise you need to feel confident about your decisions, and ensure your business stays on the right side of tax law.