Independent Contractors or Employees? When Contractors Make Sense for Your Small Business

Are Uber’s drivers contractors or employees? The question has been in the news in California, where a judge is willing to hear a class action suit that asks if the cabbies are truly employees but treated as contractors.

This matters because companies—both large and small—seek out contractors in order to access a level of expertise needed for certain projects or tasks but not all the time. This can be productive for both parties. But if you’re considering working with people outside your employ, you should understand the details of the relationship.

Learn the difference between contractors and employees, so you’ll know when contractors can benefit your business and how to make the arrangement work.

What’s the Difference? Contractors vs. Employees

A contractor is a self-employed individual who does certain work for your business on a limited basis. If you hire a contractor, you’re not responsible for withholding or paying on taxes for a contractor the way you are for an employee.

The IRS describes three common-law rules—behavioral, financial, and relational—for determining whether someone who does work for your business is a contractor or an employee. Generally speaking, the more control your business has over a worker, the less likely it is that the worker can legally be considered a contractor.

The Behavioral Rule

Behaviorally, for example, if your business can legally control where, when, and how a worker does the work, then the worker is an employee, not a contractor. A contractor agrees to produce a certain good or service, but maintains full control of how he or she produces it.

The Financial Rule

A contractor’s financial dealings with your business should usually be fairly simple: you pay a designated amount for a particular service or good produced by your contractor. It’s up to the contractor to obtain needed space, supplies, tools, and so on. Your employee, on the other hand, would reasonably expect your business to provide needed tools, resources, and workspace.

The Relationship Rule

Your business relationship is a factor, as well. If your business is providing employee-type benefits for an extended period of time, and/or if the worker is providing goods or services that are a key part of your business, you’ve got an employee, not a contractor. The IRS looks at these three rules to determine whether you should be withholding and paying tax for each workers. So, it’s important to base your payment and benefit arrangements on these rules, as well.

When Contractors Benefit Your Business

Contractors can be a great asset to your business; for a budget you and the contractor both agree on, you receive the benefits of an expert’s knowledge and skills without paying the full cost of an additional employee. (What’s in it for the contractor? He or she retains the freedom to set hours and take on additional clients.)

Specific Projects

Contractors can help you tackle specific projects, from physical improvements to marketing and financial needs. That remodel of your restaurant might require a building contractor, interior design consultant, and faux finish painting specialist. You might call in a freelance marketing expert to help with a business rebranding, or hire a graphic designer to update your menu seasonally.  But since you’re not rebranding constantly, it won’t make sense to keep such an expert on staff.

Defined Tasks

Contractors can also take on a set of defined tasks for your business. Consider your accountant, whose business relationship with you becomes increasingly important as taxes are due. Or perhaps you’re moving into more digital marketing: you can hire a digital marketing expert to run your social media pages, a writer to produce blog posts, and a web designer to bring your website into the 21st century.

The work that contractors do for you may be one-time, or it may be recurring. The key difference between these contractors and your employees is that you’re not the contractors’ only client, and the work they do for you is not the primary work of your business.

Next time you have a big project looming, it might be time to call in a contractor. Make sure the relationship meets the three common-law rules, define your projects and task, and know that you’re engaging in a business relationship that’s supporting another small business—that’s what a contractor is, after all.