Employees vs. Contractors: What You Need to Know

Now you’re probably wondering — what’s up with all the confusion and misclassification when the rules seem pretty clear-cut? One answer (discounting ignorance): cost. 

Even without offering health insurance or retirement benefits, an employee on staff means more money out of pocket for the business per hour. In addition to the per-hour or salary rate, the business must also contribute to their employees’ social security (an additional 6.2 percent on top of the base rate) and Medicare accounts (an additional 1.45 percent), pay into federal unemployment, pay into state unemployment, maintain and pay for disability and workers compensation insurance policies and, many times, pay an outside service to handle payroll. 

But trying to cut costs upfront by misclassifying your workers can backfire — big time. I once had a client who was audited by the U.S. Department of Labor to determine if he had chosen the right classification regarding his labor force. He decided they were temporary or freelance workers, the department of labor didn’t agree. The result: about $10,000 in back taxes, penalties and accounting costs to help sort the whole mess out. It was one of the costliest mistakes he ever made in business. 

So don’t be penny wise and pound foolish when it comes to deciding on employees or freelancers. If you’re sure your relationship is a freelance arrangement, hire a lawyer to draw up an agreement that indicates it. If your team member clearly meets the employee requirements outlined in the IRS guidelines, contact a qualified bookkeeper or accountant, and put them on payroll. Shelling out a little more money per hour now may help you avoid more costly problems down the road.

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