When running a business, it can be confusing when deciding who to hire: a contractor or an employee. There are pros and cons to each of these. I will be expounding on both contractors and employees.
I just recently started working with a new business who is dealing with wanting to have employees, but needing to start out with contractors. The owner understands the difference, but I am sure those working for this company don’t fully understand.
As the business owner, there is less expense involved when hiring contractors. You will find you have to pay the more per hour/job; but also keep in mind that the expenses you aren’t paying for by hiring them as a contractor, they will be paying themselves. However, you still will have to deal with the fact that the contractor works on their terms. You will want to have a signed contract that lists what you are expecting in great detail. This will benefit both you and the contractor. Things that will need to be listed in detail are things like deadlines, processes, payments, etc.
The contractor is responsible for self-employment taxes, insurance, etc. What exactly is self-employment tax? Simply defined, it is the social security and Medicare taxes that would typically be paid for an employee by the employer. When self-employed, the contractor can plan on paying 0.153 of their payments to the IRS to help cover this cost. If they do not make quarterly payments, they will end up paying this on their taxes at the end of the year.
Employees don’t have to worry about self-employment taxes. Why? Because the employer will withhold half of the social security and Medicare taxes from the paycheck (the other half is paid by the employer).
Employers are responsible for paying for workman’s comp insurance. You will need to check with your insurance provider to get the specific details as to what you are required to carry/pay for the business you are in as well as the area you are located.
As a service provider, you can plan on charging 3 times what you are paying the employee since you are in business to make money. One-third is for the total amount you pay for wages to the employee, the second-third is for the amount you are responsible to pay for insurance, taxes, etc. Finally, the last third would be your profit. This is just a general rule of thumb. There are always exceptions to every rule, so make sure you do your homework for the work you do and your geographical location.
You are also responsible to pay unemployment taxes to both the state and federal governments. For the federal unemployment taxes, it is pretty easy to figure out. You will be paying .006 of the gross earnings of up to $7,000 for each person. For example, if you have 3 employees that gross over $7,000/year, you will be paying $126 with your Form 940 (FUTA). The maximum amount you will pay is $42 per person per year. State unemployment tax is a lot more involved. There are so many variables that each state decides. Therefore, you will need to check with your state’s department of revenue to figure out how much your state unemployment tax would be.
You will also need to be sure that you have the necessary forms from your contractor/employee. When hiring an employee, you will need to have them fill out a W4 as well as the state W4. If you are hiring a contractor, have them fill out a W9. If you are not sure where to obtain these forms, you can get a current copy of each form through the IRS website as well as the state’s department of revenue website.