Contractor or New Hire?


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It’s clear that you need more manpower (or womanpower), but does it make more sense to hire a full-fledged full-time or part-time employee or obtain the services of a contractor? Like many business owners, you may be inclined toward a contractor, at least partially to avoid paying employment-related taxes associated with a new hire. However, there are potentially adverse legal consequences associated with mishandling the addition of personnel to your company.

DISCLAIMER: The following is designed to provide a general discussion of the circumstances involving obtaining the services of contractors or new hires. It is not intended to serve as legal or financial advice. Please consult with an attorney or qualified financial professional concerning specific questions relating to your particular company or circumstances.

To Hire or Contract?

There is no one-size-fits-all answer to the question of whether to hire a new employee or take on the services of a contractor. Instead, careful consideration based on your company’s structure and needs is required. In many cases, contractors rather than new hires are precisely the right choice, according. to Rich Reibstein, partner in the Labor and Employment Practice Group and co-chair of the Contractor Compliance Practice of Pepper Hamilton’s New York City offices.

“The key is whether the business needs to tell the individual how to do the job. If you only need to tell the person what to do and not how to do it, then hiring a contractor is a cost-saving option under most state and federal laws,” he explained.

Charlie Mayhone, president and CEO of MedCore Talent, a member of the Sanford Rose Associates network of offices located in Huntersville, North Carolina, agreed. According to Mayhone, companies placed an emphasis on running lean during the Great Recession, and have continued to do so even with the recovery of the economy. As a result, many companies favor contractors rather than hires, especially for lower level positions.

“It just depends on what the organization wants to do. For (filling) a just in time need, a contractor makes a lot of sense,” he said.

However, Mayhone also stated that he often advises clients to consider a temp to perm arrangement for filling crucial roles within their companies. In his view, this arrangement often provides the best of both worlds. With a temp to perm model, companies retain the flexibility of a contractor in the short term while they determine whether a potential long-term hire will fit in well with the company culture.

“It’s like a working interview,” he said.

Key leadership roles in particular should not be filled with contractors. Likewise, overemphasis on contractors can result in short-term cost savings, but with higher expenses in the long term. Contractors may be between jobs and under pressure to take the first offer they receive, but keep looking for other opportunities. Companies also need to maintain a core of actual employees to properly maintain their operations, according to Mayhone.

“You need a certain level of doctors and nurses to run a hospital efficiently. Contractors may be less aware of (crucial) regulations. It behooves all clients to do due diligence,” he said.

The Perils of Misclassification

The Internal Revenue Service has designated four categories of service providers: independent contractors, common law employees, statutory employees or statutory nonemployees. For the purposes of the specific discussion, what’s important is to determine how to properly designate a service provider to a specific category. The key is determining the level of control companies exercise over the work product of their service providers. Basically, independent contractors and statutory nonemployees have more latitude and control over how (and frequently when and where) they perform their duties than common law employees or statutory employees do.

Once you’ve made a decision on whether to hire a new service provider or take him or her on as a contractor, it’s essential that your designation lines up the classifications established by the IRS, along with state regulations. The IRS requires companies to withhold and pay unemployment, Social Security and Medicare taxes on behalf of their employees. Companies must also provide W-2 forms for employees to file with their federal income tax returns.

Service providers who believe they have been misclassified as contractors can file Form 8919, Uncollected Social Security and Medicare Tax on Wages. If the IRS finds that misclassification has occurred, the workers will have the proper Social Security and Medicare taxes credited to their records – and their companies will be held financially liable. Companies that neglect to perform due diligence in this area do so at great financial risk, according to Reibstein.

“A business acts at its peril if it fails to properly structure and document the independent contractor relationship. That may seem like it’s just dotting your “I”s and crossing your “t”s, but many of the factors looked at by the courts are counter-intuitive. Most companies don’t even get close to doing it right. Even large companies like FedEx and Uber have had trouble getting it right, and their own documents have been used against them in misclassification lawsuits, sometimes at great expense,” he stated.

Audrey Henderson
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Posted In: Management

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