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To Payroll or Not- Hiring Contract vs. Salary Employees

Nora Dunn Senior Writer, Wise Bread / freelance writer, Wise Bread Recent Posts

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July 30, 2009

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“@President - Great question. I would imagine ...”

Nora Dunn

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You have some projects coming down the pipe that you need additional staff for. What do you do: offer your potential new team player an independent contract or full-time salary position?

Generally speaking, you will pay more in hourly wages for a contractor than for a salaried employee. However, you will also save gads of money on employee-related expenses that can be burdensome. The long-term cost implications of hiring staff can be onerous if your business can’t absorb them.

Beyond dollars and cents though, are a number of factors that will help you decide whether your next hire should be a contractor or an employee.

I. EMPLOYER VIEW

A. Why Hire Contractors

1. Easy Come Easy Go
If things don’t work out with your new contractor, you don’t have to worry about sticky regulations around firing or laying-off a contractor. Severance packages are a non-issue.

2. Plans Change
If the company changes direction or a project gets canned or changed, there is no employee to fire or unemployment paperwork to contend with.

3. Quick as a Bunny
If you have a new project that needs immediate attention, you stand a better chance of acquiring a contractor faster than an employee.

4. Short-Term Projects
If you only need help for a finite duration, then a contractor may be the best choice.

5. Keep That Small Office Space
Many businesses that employ contractors don’t provide office space for them. If you have a small office to begin with and want to bring in new help, you may not need to expand your space to accommodate contractors.

6. No Health Insurance to Pay For
Because of the high cost of health insurance benefit plans, hiring a contractor – and saving this expense – can amount to big savings. Expect to save from $5,000-$10,000 per contractor per year that would be spent on an employee’s health plan.

7. Trained and Ready to Go
Contractors come ready to do the job with minimal guidance and training. This is part of what you are paying for when you pay contractors higher hourly wages.

B. The Downside of Hiring

1. Lack of Control
Independent contractors are just that: independent. They will often expect to make their own hours, and could be juggling other projects simultaneously.

2. Lack of Commitment
Without as much of a vested interest in the company, contractors might appear to be blasé about the business. This can be countered with a profit-sharing mechanism, if the contract is long-term enough for it to be an incentive.

3. Whoops – They’re Not Contract
If you made an error and your contractor really is an employee in the eyes of the law, then you could be on the hook for some of the employee-related expenses you thought you were saving like employment tax, as well as interest and possible penalties to ensure you don’t do it again. Make sure you are on top of the current legislative requirements.

4. Too Many Balls/Contractors in the Air
If you have a bevy of projects and contractors for each one, you might find yourself becoming overwhelmed from juggling too many contractors. This is when deadlines can get missed.

C. Why Hire Salary Employees

1. Long-Term Needs
If your needs are for full-time long-term work, then hiring an employee often makes more sense.

2. Key Management Positions
In order to ensure that the right knowledge base stays with the company after a project ends, you may want to fill key project management positions with employees.

3. Confidentiality
If the information to be dealt with is confidential or sensitive in nature, employers often feel that this information is most secure with employees, not contractors.

4. Loyalty + Promotion = Productivity
If your employees are loyal to you and the company, you will have a team of people working for the betterment of the business. If you have a chance to promote these employees (if not with a raise, then possibly tax-free perks or a shift in role), they may in-kind respond with heightened productivity.

5. Flexibility
Small businesses especially require their staff to work in multi-faceted roles which continue to evolve with the business. This will keep employees motivated and stimulated, whereas contractors might be unwilling to move beyond the scope of their expertise.

D. Downsides of Hiring Salary Employees

1. Extra Expenses
Employee-related expenses include training, health insurance, paid vacation, paid sick-leave, retirement plans, worker’s compensation, payroll taxes, social security taxes, unemployment taxes, and others, depending on your industry and business. Technically these expenses even out the additional money you would pay a contractor in wages, but this is not always so. The long-term costs of having an employee can often be higher than a contractor.

2. Office Space
You have to provide an ergonomic workspace for your employees. Expanding your staff might also entail expanding your office space to accommodate them.

3. Management Blues
You probably started your small business because of your inherent industry-related expertise and skills. But now that your company is growing its employee base, you are forced to be a people manager. Employees, as a general rule, require more hand-holding than contractors.

4. Liability
You open yourself up to employee/work-related lawsuits by having employees on the roster.

II. EMPLOYEE VIEW

No employer’s analysis would be complete without stepping into the shoes of their employees as an acid test. Here are some reasons why your employees might prefer a contract or staff position.

A. Why Choose a Contract

1. Hourly Wages
A contractor earning an hourly wage might also be eligible for overtime, paid at time-and-a-half. Salaried employees make a flat wage, regardless of the hours worked.

2. Tax Deductibility
Employees cannot deduct any expenses related to their job, including transportation to and from work. Contractors however, can deduct just about any expense they bear that can be construed as enabling them to do their job, including home office space, auto expenses, insurance, utility bills, computers, and office supplies. Please note though, that a dollar deducted from your income for tax purposes does not equate to a dollar saved in taxes. If this is money the contractor would spend anyway as an employee, then they will see an overall savings.

3. More Money
Typically, independent contractors will make more money than employees in the same position. Even after expenses and taxes, this amount can still be higher, but is entirely dependent on the individual situation.

4. More Control
Contractors ultimately have control over their schedules, working conditions, and projects.

5. Ability to Freelance
Some employer-employee agreements prevent employees from working at other jobs, especially if they are industry-related. In some cases employees are prevented from working for competitive companies even after they have left their current employment. Being a contractor circumvents these issues.

B. Downsides of Being a Contractor

1. Business License Requirements
Depending on the location, industry, and income, contractors are required to have a business license, which can be an additional annual expense.

2. Accounting
Contractors have to be on top of their accounts, including invoicing and receivables, taxes, deductions, and various other detailed matters that require a level of organization that is not always natural or easy.

3. No Extra Perks
Contractors don’t get holiday pay, health coverage, sick pay, retirement plans, annual bonuses, or a host of other employee perks.

4. No Unemployment, No Safety Blanket
If your contract ends unexpectedly, you are not eligible for unemployment benefits since you are considered to be self-employed.

5. Extra Taxes
Contractors must pay the employer portion of all taxes, including federal, state/provincial, and sometimes even municipal taxes.

6. Always On the Hunt
Contractors are always on the hunt for new contracts to either supplement their existing work or to replace expiring contracts. Shaking trees for leads is not everybody’s forte.

7. Higher Cost of Insurance
Employer-sponsored health insurance plans often cost much less (due to the spread of risk across a group) than individual health insurance plans necessary for contractors. There is a loophole though: sometimes contractors who belong to a professional group or association may be eligible for group benefits through them at a discounted rate.

8. Lack of Job Security
This is a big one, and is not to be underestimated. Employees receive regular paychecks, sick leave, vacation benefits, and various fringe perks. All they have to do is show up. For some, this peace of mind is a significant enough benefit to counteract all the potential advantages of choosing a contract position.

III. GUIDELINES FOR HIRING CONTRACTORS

1. Payscale
The general rule of thumb is that a contractor’s wages should be about twice an employee’s salary for it to be worthwhile. While this figure may seem steep, consider that fringe employee benefits cost 20-50% of a salary, in addition to the employer-related taxes and fees you pay on behalf of the employee.

2. Business is Business
The contractor/employer relationship is much more a business relationship than an employee/employer relationship, which has extra scope. For you, this extra scope may be desired, or conversely, avoided at all costs.

Whether your next hire is one of an employee or contractor will depend on where your business is, what your needs are, and what the industry outlook is in your line of work. Some people will prefer taking on contract positions, while others will run screaming from them. However with this framework above as a guide, hopefully your next hiring

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Nora Dunn, Article, payroll, financial planning, managing employees, salary

What do you think?

Join the conversation ( 5 )

Nora Dunn 1 year 6 months and 26 days ago

@President - Great question. I would imagine that the same rules would apply whether your contractor is traveling vs working for you in your home town. Although I would suggest you consult with your financial planner or insurance agent for specific legislation in your area, I would imagine that care for injuries are the responsibility of the contractor, as per most contractor/employer regulations. (Please don't quote me on that though!) Does anybody else have something to weigh in on for this matter?
MARG WARNER 1 year 6 months and 27 days ago

This is really helpful. However I have a question which I'm hoping someone can answer - what are my liabilities as an employer if i have a contractor traveling for me on business - and something happens to them (ie injury)?
Nora Dunn 2 years 5 months and 11 days ago

Great tips, Paul! Thanks for your input. I especially like your willingness to negotiate contract payscales, as well as your requirements for a standard NDA. Covering all the bases is very important.
PAUL ROSENFELD 2 years 6 months and 10 days ago

One more thing on guidelines: Don't have someone start without a standard NDA and "Work for Hire" contract that stipulates you own all work. Just because they're a contractor don't skirt these basics such as a vendor contract, setting down the groundrules/project brief with clear deliverables. Ensure you protect access to critical systems and terminate credentialed access as soon as contractor leaves. And finally, just b/c they're a contractor doesn't mean they're not a super critical part of your team - mentally treat them like an employee and they'll do their best for you.
PAUL ROSENFELD 2 years 6 months and 10 days ago

This is perhaps the best concise explanation I've seen of the Pros/Cons. We're a huge fan of Contractors and have about a dozen with no employees. We only pay equity so I'd say your rule of thumb around paying 2X employee rates can really constrain your creativity and a owner should be as aggressive as possible in this economy given lots of out of work folks who might work just to patch a hole in a resume and be around interesting projects. It's important to ask "Why do you want to work?" and listen for what comes back.