Employee vs. Contractor

CraftsLaw025An independent contractor (IC) provides services on a per-project basis, usually for a number of clients.  An employee, on the other hand, is not running his or her own business but follows the rules and standards required by the employer. As an employer,  you exercise more control over an employee, from setting work hours to imposing a dress code to dictating exactly how the employee does every aspect of the job. If your crafts business misclassifies a worker as an employee, not an IC, you may run into problems with the state unemployment insurance agency, the state workers’ compensation board, and the IRS. (The IRS, in particular, imposes hefty penalties for misclassification.) The IRS test considers workers employees if the company they work for has the right to direct and control the way they work—including the details of when, where, and how the job is accomplished.

Firing an employee vs. firing a contractor

Strictly speaking, you can’t fire an independent contractor. If the contractor fails to perform the services—that is, breaches the agreement—you can terminate the agreement. But if the contractor has performed and you terminate your agreement without a legal reason, the independent contractor can sue you to recover lost wages.

You can fire at-will employees. Most employees are considered “at will,” which means  they are free to quit at any time, for any reason,  and you are free to fire them at any time and for any reason. There are, however, two limitations on firing:

  • An employment contract limits your ability to terminate. Whether written, oral or implied, an employment contract can limit your right to fire the employee. The language or nature of the contract usually spells out the terms of employment, including when and for what reasons the employee can be fired.
  • State or federal laws may prohibit the firing. You’re prohibited from firing, disciplining or demoting an employee in bad faith, in violation of public policy or for a discriminatory or retaliatory reason.

Generally, you may fire an at-will employee for even the most idiosyncratic reasons—for example, you simply want to hire someone else as a replacement. You are also free to change the terms of employment—job duties, compensation or hours, for example—for any reason that isn’t illegal. Your workers can agree to these changes and continue working or reject the changes and quit. In other words, the employment relationship is voluntary. You cannot force your employees to stay forever, and they cannot require you to employ them indefinitely.

If you’re considering hiring someone for your crafts business, you’re usually going to prefer hiring an IC. Here’s why:

  • ICs require less training. Unlike an employee, whom you may have to train, an IC will be ready to go on day one and will have the skill and background to do the job right. ICs also have a stronger incentive to finish the work quickly.
  • ICs are always a better choice for short-term tasks. If you have a specific project or task you need done (for example, a one-time electrical job or help designing your packaging), you’ll probably want to hire an IC.
  • Costs are lower with ICs. Your total cash outlay will probably be lower for ICs than employees. Although an IC is likely to charge you more to do a project than you’d have to actually pay an employee, employees are more expensive overall after you add on taxes, insurance costs, the price of equipment, materials, and workspace, and other cash outlays.
  • ICs are better for your cash flow. State and federal laws set strict guidelines for paying employees. You have to pay at least the minimum hourly wage, and you have to pay them according to a schedule set by state law (anywhere from once a week to once a month). If you don’t follow these rules, you could face fines and penalties. For an IC, you and the IC will set the pay schedule yourselves. If your clients pay you by the project, you can pay the IC when you get paid. If you won’t be able to pay for a while, you can work out an installment arrangement with the IC.
  • ICs require fewer rules and red tape. Unless you’re ready to learn your legal obligations as an employer,  set up a payroll system to withhold taxes and pay them over to the IRS, don’t hire employees. You can run into trouble quickly if you don’t handle employee matters by the book.  For an IC, on the other hand, the paperwork is minimal. Keep in mind, however, that government agencies will take a close look at ICs to make sure they shouldn’t have been classified as employees. This means you may be a more likely target for an audit if you hire ICs.

Read more about hiring independent contractors.