When you run a business, there comes a time when you cannot do everything on your own. This is especially true as your business keeps expanding. Lots and lots more tasks get added onto your plate and you simply do not have time to do it by yourself. So now we are left with a choice – to hire employees or to hire subcontractors that are also known as independent contractors.
In making this choice it’s vital that you know their difference and classifies them accordingly. Otherwise, you may end up in some financial trouble involving taxes and even penalties.
So what are the differences that we need to know about an employee and a subcontractor? What obligations do we have for each of them? What do we have to consider? These are just some of the questions we will answer today.
The difference between an employee and a subcontractor
The internal revenue service (IRS) will always get the final say on whether someone should be considered an employee or a subcontractor. Therefore, it’s important to understand the IRS guidelines too. This will help us in determining ourselves more accurately.
For this, the IRS has three key areas that they look at when they classify whether someone is your employee or subcontractor. These are those three areas you also need to take note of:
Behavioral control
In this category, the IRS takes a look at the instructions, the kind of training a worker has, and the evaluation of their performance.
For instruction, it refers to the degree or amount of instruction given to a worker when they are performing their roles. These instructions can include when or where these workers will do their jobs, as well as the kinds of tools and supplies that they require.
If you give all of these to a worker, then they will be considered an employee as subcontractors generally have more freedom when it comes to these factors.
Another part is training. You see, most subcontractors don't really require in-depth training, unlike employees. Most of the time, subcontractors are hired mainly because they already possess the skills and training that you require for your company. Hence, if you give them training to make them more suitable for your business, then they are your employees.
Related to instructions and training, the way a worker is evaluated is also considered. If you evaluate them based only on their results, then you will have to classify them as subcontractors.
Financial control
This aspect takes a look at whether your business and the work the worker does can affect their financial state. This includes things such as whether the worker buys their own equipment, gets reimbursements, etc.
To elaborate, if your worker’s equipment was provided for by you, then they are most likely an employee. On the other hand, if they buy and use their own equipment, then they are subcontractors. This is because most subcontractors already have the equipment they need on hand.
In addition, employees are also more likely to be reimbursed for their expenses than subcontractors. These expenses may include (but are not limited to) transportation fees, the cost of supplies, etc. Subcontractors generally do not get reimbursed for these kinds of expenses.
When it comes to their salary, as we know employees are paid on a regular basis be it by the hour, bi-weekly, or monthly. If you paid him by the hour, then they are most likely considered an employee. Otherwise, they are a subcontractor.
Relationship control
This key area mostly refers to the formalities written in a contract. Since contracts define the relationship between an employer and a worker, the way the contract is written can also affect whether they are considered an employee or a subcontractor by the IRS. Therefore, it is very important to clearly define the terms in your contract with a worker.
For instance, in your documents such as a contract, you should clearly state whether a worker is an employee or a subcontractor only. This will help make it clear from the start what your intended relationship with the worker actually is. However, you must take note that simply having a contract saying they are a worker or a subcontractor will not be the only defining reason for the decision of the IRS on what classification they would fall under.
This is because there are also benefits such as health insurance, paid vacations, and sick leaves that are only given to employees and not to subcontractors in general.
Just as you've documented the start of the intended relationship, the contract should also put a clear definition of when or how a worker will be terminated from their services and how long their contracts will last. Employees tend to have permanent or ongoing contracts that are renewed periodically, while subcontractors are hired mostly for specific projects for their specialized skills.
Other factors you have to consider
There are also other legal factors that we have to keep in mind when you have to classify whether your workers are employees or subcontractors. These are the other factors you have to keep in mind to avoid any legal or financial troubles.
The first thing you have to keep in mind is to put everything down in writing. Everything must be documented in the processes starting from hiring. So regardless of whether they are an employee or not, you must clearly define the terms of your relationship with them to avoid any confusion in the future. Aside from a contract, employees can also make use of an employee handbook. This will clearly tell them the guidelines and procedures they have to follow as an employee of your business. For subcontractors, a clearly defined contract is more vital as they can work on their own most of the time.
Another thing you have to consider is using non-disclosure agreements (NDA). There will be times when employees or subcontractors can gain access to confidential data of your business or of your clients themselves. Therefore, it's very important that you protect yourself, your privacy as well as your clients. Having an NDA will protect you and your clients from any confidential information being leaked out without your consent.
In the same vein as NDA's, a non-compete clause or non-solicitation clause will also help you out a lot. Having a non-solicitation clause will prevent any workers from soliciting anything from your employees while they are working, while a non-compete clause will prevent any competitors from secretly working under you just to undermine your business later on. This will prevent any employee from stealing your clients should they get an idea to start their own business as well.
In conclusion, hiring subcontractors frees you from more tax obligations, but it also means you have less control over their work process. On the other hand, hiring employees will allow you to have more control over the quality and amount of their work, but leaves you with more tax obligations. Now that you know the clear differences between hiring an employee versus hiring a subcontractor, you can now make a better decision when it comes to hiring your workers. So good luck with your business and may it thrive with the help of the people you hire.