Should You Recruit an Employee or an Independent Contractor?

Companies attempting to keep costs low may consider recruiting independent contractors instead of permanent employees.

While the notion may seem attractive on its face, however, anyone responsible for recruiting talent should understand the critical differences between the two before choosing which to recruit.

Conflating the two, even inadvertently, can lead to greater costs to the company in the long run.

As we “celebrate” tax season, arm yourself with the knowledge about which type of worker is which.

If you are not sure whether you should be recruiting an employee or an independent contractor, you can evaluate the open position based on the following general descriptions that are based on the IRS’ common law rules for classifying workers*:

An employee provides services to the company for an established, regular salary or hourly wage. She must track her time and work according to the employer’s preference using a time clock or other logging system. Based on her status she may qualify for benefits such as retirement plans, health insurance, or paid time off.

The employer enumerates her job requirements and the accepted processes for fulfilling them, and provides her with the necessary tools and supplies to do her work. She is typically discouraged from holding similar positions with other companies at the same time.
An independent contractor provides services to the company on an as-needed basis that may be regular or sporadic and is likely set forth in a business agreement. The contractor is not required to work a certain number of hours or to log hours worked, unless his payment is an hourly fee. The company pays his fee according to the settled agreement.

He may work on concurrent projects with multiple companies and is not regulated by the contracting company. He chooses which assignments to take and how to fulfill them, and may use his own tools and equipment to complete his work or may use space and supplies set aside by the company. He is not eligible for company benefits beyond legally mandated protections available to all workers.

Classifying a worker as an independent contractor shifts the responsibility of tax withholding and reporting from the employer to the worker and exempts the company from payroll tax liability for that worker. However, if the IRS determines that a worker has been improperly classified then the company may have to pay penalties in addition to taxes going forward.

There are specific pros and cons to recruiting employees versus independent contractors, many of which are discussed above. The most important distinction between the two, though, is a company’s responsibility for proper reporting and payroll administration – which is why it is essential to know the difference. If you are recruiting for “independent contractor” positions that sound more like “employee” positions, you can save your clients money and frustration and make yourself an invaluable asset to their recruiting team.

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Comment by Jerry Albright on March 6, 2014 at 3:20pm: If the 1099 person pays their taxes - what is the potential problem? As long as the employer side of taxes are paid, then I see absolutely no reason to force them into an employee relationship.

Comment by Shannon Trenton on March 7, 2014 at 9:32am: Good question. In terms of the independent contractor fulfilling their own tax obligation there is no issue for the employer.

The issue arises when an employer uses an independent contractor to avoid the associated taxes on their end but then treats the contractor as they would an employee. If an IRS review of the worker in question determines that the worker has been improperly classified, the employer can face stiff fees and penalties.

For example: I am currently an employee at one company and an independent contractor associated with another company. My employer can dictate my schedule, what I am allowed to access on company equipment, and the work he expects me to do. He can also require that I sign any form of non-compete clause. He must pay employment taxes and withhold taxes from my paycheck.

The company for which I am an independent contractor, however, cannot control the hours I work or how I run my business with them as long as I abide by the contract that I signed with them. I receive gross payment from them and am responsible, as mentioned above, for covering my own tax obligations through proper reporting and payment. If this company begins requiring that I work certain hours or that I perform my work in a certain way (generally speaking), then in the eyes of the IRS I have become an employee of that company and their tax obligations change.

Thanks for reading!

Comment by Jerry Albright on March 7, 2014 at 10:02am: But.....even IF they treat you like an employee.......if you pay your taxes in accordance with the law, there is no issue. Problems arise WHEN a 1099 does not pay their taxes AND it can be proven they, for all intents WERE an "employee" from all other perspectives.

Comment by Shannon Trenton on March 7, 2014 at 10:48am: But there is an issue in that instance, because if a worker is an employee then the employer is required to pay taxes on their payroll in addition to their withholding from the employee's pay. The employer must also cover half of the Medicare withholding from each employee's check.

Additionally, with the implementation of the Affordable Care Act they can be held liable for not counting that worker in their reporting of how many full-time employees they have, if applicable, and can be penalized for not offering health insurance to that worker if they are required to by the law.

Trust me, the distinction is critical. An independent contractor is not an employee, and has every right to request a review from the IRS. It's better to know what you want from your worker and decide what the position should be before you even begin recruiting for it than to have the IRS knocking on your office door later.

Comment by Jerry Albright on March 7, 2014 at 10:52am: Payroll/Back Office/Factoring, etc. companies are ALWAYS trying to scare businesses way from 1099 "talent". Other than ACA requirements (pushed off yet again until who knows when) there is NO actual negative IF the person is paying their taxes. There is not "additional" money that would be paid to the Feds if the person were W2 rather than 1099.

If I am not correct here, please help me clarify my thinking. The "employer side" of taxes is paid by the 1099er. Those very same taxes are paid by the "employer" when on W2. What other tax is their? (I am not talking about workers comp, etc.) Just employment taxes.

Comment by Shannon Trenton on March 7, 2014 at 11:45am: This is certainly not an attempt to scare companies away from independent contractors. For many offices it makes perfect sense to work with contractors on an as-needed basis rather than bringing in permanent employees who may add very little long-term benefit to the company.

You are right that the employment tax is shifted to the independent contractor in the form of self-employment tax, though the actual dollar amounts may differ.

The risk to an employer is that an independent contractor who receives "employee" treatment (and I'm talking about control over workflow, etc., not whether they can use the employee break room) outside the terms of their agreement may request the IRS to review their status. If the IRS determines they are an employee then that is when a company can face penalties.

Of course, a company can request the same determination from the IRS if they want to cover their bases.

If a company chooses to recruit independent contractors then the best practices to avoid all of this are to A) understand the IRS' distinction between the two worker types and B) carefully follow the established agreement with the contractor.