Your small company has a three-month project for a new client. Do you take on a new employee or hire an independent contractor?
Many business owners find there are great benefits to using independent contractors, especially when their work tends to be on a project-by-project basis. They can hire people with different specialties according to the demands of each job. Using contractors also allows small businesses to save on overhead, because contractors aren’t paid benefits.
But there are also some drawbacks. Independent contractors are free agents and, some business owners find, not always reliable. And owners need to be careful when using contractors that they don’t treat them in a fashion that could land the company in trouble with federal and state tax authorities.
Business owner Peter Shankman had about 15 employees in his previous public relations firm, but now uses only independent contractors. He found that being an employer and having to deal with the accompanying administrative issues took away from his enjoyment of his work.
“It was no longer fun,” said Shankman, owner of New York-based The Geek Factory Inc. “It was no longer about sitting down and coming up with these wacky idea. It became about making sure everyone had health insurance and making sure everyone had a 401(k).”
Now, Shankman has what he calls “my gang,” five people he hires individually, depending on what project he needs done.
Greg O’Lone uses independent contractors to keep costs down at his Jacksonville, Fla.-based business, Stretched Out Software. “The biggest reason that we do this is the cost of health care – it’s absolutely exorbitant to deal with,” he said.
Daniel Pearson, who owns Porchfire Communications, an Apex, N.C., marketing firm, finds that hiring independent contractors is a much more efficient way of working. “Contractors want to get things done on time,” he said. “They want to be paid, and keep getting paid.”
Still, independent contractors can have drawbacks. Shankman recalled a would-be client who was uncomfortable with the idea that The Geek Factory had no full-time staff. “I said, ‘Look, I can have as many people as you want.’ But we lost to a big agency.”
And O’Lone, who has a good group of contractors, said he’s found some aren’t always as dedicated as his employees. “They’re there regularly – there is some responsibility to show up for work,” he said of employees. “With independents, sometimes you don’t get that. You get, ‘I’m going to the beach today.’”
There are also some legal and tax pitfalls owners need to be aware of. How you treat an independent contractor could, according to the government, make him or her your employee. In that case, you would owe Social Security and Medicare taxes, and unemployment and workers’ compensation insurance premiums.
Stephen Fishman, an attorney and author of “Hiring Independent Contractors,” noted that with an employee, as opposed to an independent contractor, “they work for you, you provide them with all the tools and office space, you tell them what to do, how to do it, when to come to work, when to take their lunch.”
“The IRS calls it the right of control. It’s the key factor in determining whether you’re an employee or independent contractor,” Fishman said.
On the other hand, an independent contractor is likely to work away from your premises, set his or her own hours and do the work according to your specifications, but not under your supervision. Fishman noted that contractors are not trained by the people who hire them, and unlike employees, they can refuse to do work they don’t like simply because they’re not under the owner’s control.
There are some gray areas. Let’s say you have work that needs to be done on specialized software that you have on PCs in your office. It’s likely an independent contractor can work in your office and not lose that classification, as long as he or she still fits the other requirements to be called a contractor.
Many businesses hire independent contractors with little or no paperwork, and that can lead to serious consequences if the relationship sours. Fishman said some business owners have found themselves being audited by tax officials after an unhappy independent contractor filed a claim for unemployment insurance – which, even if it’s a false claim, can still create headaches.
If the authorities decide the relationship was actually that of employer-employee, a company could be liable for unpaid benefits, taxes and penalties.
There are several things owners can do to protect themselves.
First, they need to create documents that carefully describe the relationship with the independent contractor, said Jeff Phelps, chief operating officer of ABE Services, a human resources compliance firm in Sonoma, Calif.
Then, during the course of the working relationship, “they need to be sure they do not begin treating that person as an employee,” Phelps said. “They shouldn’t dictate to them … how they should do the work.”
And be careful about the length of time your contractor works for you. “Does a 12-month engagement become three years? It becomes harder and harder to demonstrate that they’re not an employee,” Phelps said.
Small Business is a weekly column on small business topics by The Associated Press.
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