Hire a Contractor or an Employee

Independent contractors and employees are not the same, and it's important to understand the difference. Knowing this distinction will help you determine what your first hiring move will be and affect how you withhold a variety of taxes and avoid costly legal consequences.

What’s the Difference?

An Independent Contractor:

• Operates under a business name
• Has his/her own employees
• Maintains a separate business checking account
• Advertises his/her business' services
• Invoices for work completed
• Has more than one client
• Has own tools and sets own hours
• Keeps business records

An Employee:

• Performs duties dictated or controlled by others
• Is given training for work to be done
• Works for only one employer

Many small businesses rely on independent contractors for their staffing needs. There are many benefits to using contractors over hiring employees:

• Savings in labor costs
• Reduced liability
• Flexibility in hiring and firing

Why Misclassification of employee or Contractor Matters

Misclassification of an individual as an independent contractor may have a number of costly legal consequences.

If your independent contractor is discovered to meet the legal definition of an employee, you may be required to:

• Reimburse them for wages you should've paid them under the Fair Labor Standards Act, including overtime and minimum wage
• Pay back taxes and penalties for federal and state income taxes, Social Security, Medicare and unemployment
• Pay any misclassified injured employees workers' compensation benefits
• Provide employee benefits, including health insurance, retirement, etc.

Tax Requirements

Visit the IRS Independent Contractor or Employee guide to learn about the tax implications of either scenario, download and fill out a form to have the IRS officially determine your workers’ status, and find other related resources.

Employment Information

There is no single test for determining if an individual is an independent contractor or an employee under the Fair Labor Standards Act. However, the following guidelines should be taken into account:

1. The extent to which the services rendered are an integral part of the principal's business
2. The permanency of the relationship
3. The amount of the alleged contractor's investment in facilities and equipment
4. The nature and degree of control by the principal
5. The alleged contractor's opportunities for profit and loss
6. The amount of initiative, judgment, or foresight in open market competition with others that is required for the success of the claimed independent contractor
7. The degree of independent business organization and operation

Whether a person is an independent contractor or an employee generally depends on the amount of control exercised by the employer over the work being done.

Other Resources

Read Equal Employment Opportunity Laws - Who's Covered? for more information on how to determine whether a person is an independent contractor or an employee, and which are covered under federal laws.

Author

This article was authored by the US Small Business Administration

The U.S. Small Business Administration (SBA) was created in 1953 as an independent agency of the federal government to aid, counsel, assist and protect the interests of small business concerns, to preserve free competitive enterprise and to maintain and strengthen the overall economy of our nation. The SBA helps Americans start, build and grow businesses. Through an extensive network of field offices and partnerships with public and private organizations, SBA delivers its services to people throughout the United States, Puerto Rico, the U. S. Virgin Islands and Guam. The SBA provides assistances primarily through four programs:

• Business financing programs including debt, equity and micro lending
• Entrepreneurial development through education, information, technical assistance & training
• Promotes small business Federal Government contracting with subcontracting procurement opportunities, outreach programs, and training to help meet the 23% goal for small business contracting
• Advocacy and research on behalf of small businesses

Detailed information is available at the SBA website and a detailed Resource Guide is available in English and Spanish on the website.