Think hiring: Employees vs. contractors

In this Think column, Venture Legal founder Chris Brown explores the dynamics a growing company faces when it needs to hire an extra set of hands. The Think column helps entrepreneurs to stop and think about the various aspects of starting and running a business. Read ThinkViral President Anne Cull’s introduction to the series here. 

Chris Brown

You’ve started a company, closed some deals, and you’re ready to hire your first employee. But are you really ready for an employee, or is an independent contractor better?

If you hire an employee you will have more control over their work and performance, but you’ll pay more to the government and have more administrative work to perform. If you hire a contractor, you loose some control but it is often much easier.

Tax Considerations

Life is easier when you hire independent contractors because contractors are responsible for paying their own income taxes and also the entire amount of self-employment taxes (mainly social security). Your main responsibility is to provide contractors with IRS Form 1099 if you pay them more than $600 in one year (and you should request a Form W9 from them).

On the reverse, when you employ a worker, you must withhold (and pay to local, state, and federal taxing authorities) a portion of the worker’s salary for income taxes and their half of employment taxes, plus your half of those employment taxes, plus state and federal unemployment taxes and contributions to workers compensation funds. This means that your company will have to pay about 10% more because the worker is an employee, plus you’ll have to manage the administrative side of the process. Luckily, some online companies make this easy (I use Zen Payroll and find their platform easy to use).

Work Performance Considerations

When you hire an employee, you have a lot of control over when and where they work and how they perform their jobs. The down side is you often have to provide them with office space, equipment, and other things that cost you more money.

When hiring a contractor, you give up a lot of that control. However, in most situations a contractor will provide all of their own equipment, which means you can save money.

Intellectual Property

Copyrights in and to original creative works usually vest in the creator. Thus, when you engage a contractor, he or she will own all copyrights to the works they create. For this reason it is necessary for you to agree in writing that their works are “works made for hire” and therefore owned by your company.

However, when you hire an employee, all works they create that are within their scope of employment will be owned by your company by default.

Termination Rights

Most employees are “at will” employees meaning you (and them) can terminate the relationship at anytime. That is a big benefit to hiring employees over contractors.

When you engage a contractor, your termination rights will be governed by your contractor agreement, which is usually negotiated between the two parties.

What the IRS Says

You can call your workers whatever you want and, while that plays a role in determining if a worker is an employee or contractor, it isn’t the deciding factor. Rather, the IRS will consider the following.

A worker is likely an employee if (a) you control when, where, and how, the worker performs services; (b) you provide the worker’s tools and equipment; (c) you control how and when the worker is paid; (d) you give them employee-style benefits; and/or (e) the relationship doesn’t have an end date.

A worker is likely an independent contractor if (a) the worker controls when, where, and how, he or she performs services; (b) the worker provides his or her own tools and equipment; (c) payment terms are controlled by the worker; (d) the worker doesn’t receive employee-style benefits; and/or (e) the worker works on a project basis.

What you should do

Obviously this decision can have major consequences, both good and bad, for your company.

One good practice is to engage new workers as contractors for some period of time, perhaps three to six months. Test them out and if they are a good fit, then offer them employment. If not, simply move on to someone else.

Just be careful; if the worker falls into the employment description above then the IRS may consider them an employee (even if you call them a contractor). If that happens you may end up owing the government a lot of money.

And as always, a good business lawyer can help you with these thorny issues. So send us an email if you have questions about your situation. 

Chris Brown is the founder of Venture Legal. He’s founded multiple companies and is a huge supporter of the Kansas City startup community. Follow Chris on Twitter @CSBCounsel

* This article is very general in nature and does not constitute legal advice. Readers with legal questions should consult with an attorney prior to making any legal decisions.