Digital technology and new business practices are disrupting traditional employment relationships. Companies worldwide are now relying on independent contractors in order to cut overhead costs, save time and improve operations. The number of workers with independent-contractor income has increased by a staggering 22% between 2001 and 2019, according to an IRS report. This trend may represent a structural shift in the labor market and may open new opportunities for business growth.
TL;DR (Too Long; Didn't Read)
Independent contractors can free up your time, reduce your overhead costs and give you access to a global talent pool. When you have the right mix of employees and contractors, you can leverage their skills to unlock innovation and grow your business.
What Is an Independent Contractor?
The internet abounds with stories about digital nomads, freelancers and successful people who work on their own. They make their own schedule, work from anywhere and feel grateful for not being stuck in the nine-to-five grind. Many of them are independent contractors, meaning that they provide services to other companies and individuals under a contract or agreement. From a legal perspective, they are self-employed.
However, freelancers are not the only ones who fall into this category. Doctors, accountants, lawyers and other professionals who offer their services to the general public typically have independent contractor status. A doctor who works in a hospital, for example, is an employee, but one who owns a medical practice that is hired out by other companies is an independent contractor, and therefore, his earnings are subject to self-employment tax.
Contractors have a higher degree of control over their work than employees. To put it simply, they are the ones who decide what will be done and how it will be done. The downside is that they must pay income tax on their own and are not covered by employment and labor laws. Generally, the IRS assesses each situation on a case-by-case basis to determine whether an individual is an employee or an independent contractor.
How to Properly Classify Workers
As a business owner, it's important to know the difference between employees and independent contractors. Otherwise, you may end up having to pay wages, Social Security and Medicare taxes and cover the costs of unemployment insurance and pension plans According to the IRS, worker classification depends on three factors: behavioral control, financial control and the employer/worker relationship.
Behavioral control refers to the way work is done. Individuals who can set their own work hours and have control over what they do without receiving training or being told what tools to use are considered independent contractors. However, if they receive training on how to do the job and their work is coordinated and assessed by the client, then they are considered employees.
Next, you need to consider how the worker is paid. In general, independent contractors charge project fees or hourly rates and have the freedom to work for multiple clients at the same time. Employees, on the other hand, are paid a fixed salary for full-time work (and a commission in some cases) and may be restricted from working for other companies during their employment contract.
The employer/worker relationship matters too. Just because you have a written contract with a worker doesn't mean she can't be considered an employee. If she receives benefits or her services are essential to the proper functioning of your business, it may indicate an employer/employee relationship. Small-business owners may use Form SS-8 to determine a worker's status and avoid the legal consequences of misclassifying employees.
Employees vs. Independent Contractors
There are several major differences between employees and independent contractors. First of all, employees are covered by federal and state employment and labor laws, such as the Fair Labor Standards Act. These regulations don't apply to those who work on their own.
Second, independent contractors usually interact with potential clients online or in person, submit a proposal and sign a contract that outlines what their work involves, how much they will be paid and so on. Potential employees apply for jobs online or in person, but their application is handled by human resources. If they qualify for the job, they receive an offer and sign an employment contract. Then, they are required to fill out Form W-4, provide personal information and undergo training.
Employers report the wages paid to their employees using Form W-2. If they work with independent contractors, they must use Form 1099-MISC to report payments of $600 or more in a calendar year. Another difference is that employers pay independent contractors after receiving an invoice, while an employee's pay period typically remains the same unless the employment contract states otherwise.
Additionally, many contractors operate as as independent business. They are registered as sole proprietors or LLCs and specialize in one area or another. Therefore, they bring their expertise to the projects on which they work and don't require training. Unlike employees whose jobs may encompass a wide range of tasks, contractors only provide the services specified in a contract.
Benefits of Hiring Independent Contractors
About 6.9% of all workers in the U.S. are independent contractors, reports the Bureau of Labor Statistics. Furthermore, 63% of executives would embrace this career path and nearly 80% say that leveraging contractors gives them a competitive edge.
Digital transformation and modern technology are pressuring companies to evolve and expand. As a small-business owner, you too can leverage the gig economy to develop better products and services, reduce overhead costs and have access to the latest tech. Contractors can use their skills and expertise to help you grow your business quicker while saving time and money. Depending on your needs, you may work with independent professionals who specialize in any of the following fields:
- Accounting and bookkeeping
- Graphic design
- Product photography
- Digital marketing
- Search engine optimization
- Software development
- Technical writing
- E-commerce development
- Project management
Say you're looking for a professional graphic designer to create illustrations, posters, brochures and other marketing materials. The median annual salary for a junior graphic designer in New York City is around $43,317 plus benefits. A senior graphic designer receives over $71,000 per year. As a small business, you may not be able to afford these costs, but you can hire independent contractors and pay a flat fee per project.
Flexibility, reduced labor costs and access to a global talent pool are some of the biggest advantages of working with independent contractors. You can choose from thousands of professionals with different skill sets and abilities without having to pay an arm and a leg. Plus, you can terminate the contract at any time without giving a reason and dealing with extensive paperwork, as is what happens when you decide to fire an employee.
Are There Any Drawbacks?
Hiring independent contractors isn't always the best option, especially when they are working remotely. You can have bad luck and stumble across someone who is unreliable or untrustworthy. On top of that, you may not have their full attention since they are working with several other clients. One way to address these issues is to use some sort of employee monitoring or time-tracking software, such as TimeCamp, TSheets or eSub.
Another potential drawback is that independent contractors are not loyal to any one company, and therefore, they may leave when you least expect it. In the worst-case scenario, they may go to your competitors and disclose your trade secrets. For this reason, it's recommended to ask them to sign a nondisclosure agreement and/or a noncompete agreement.
Make sure you have a written contract and/or independent contractor agreement that clearly states the rights and obligations of each party as well as who owns the copyright of works created by a contractor. The contract should also state that you are not responsible for paying any wages or benefits. Companies that hire independent contractors are at a greater risk of government audits, so it's important to have everything in writing.
Many problems that affect the employer/worker relationship stem from poor communication. Consider using online tools like Skype, Slack and Trello to keep in touch with the contractors with whom you work. Ask for updates and reports every few days, provide clear instructions and reply to their inquiries promptly. Focus on building a lasting business relationship and keep them engaged by offering them additional work on a regular basis.
- IRS: Independent Contractors in the U.S.: New Trends From 15 Years of Administrative Tax Data
- IRS: Understanding Employee vs. Contractor Designation
- IRS: About Form 1099-MISC, Miscellaneous Income
- Bureau of Labor Statistics: Contingent Work and Alternative Employment Arrangements
- Mavenlink: Mavenlink Study Finds That Senior Executives, Not Millennials, Driving US Towards Gig Economy
- Shillington: The Complete Graphic Designer Salary Breakdown
- Nolo: Pros and Cons of Hiring Independent Contractors
- Xero: The Pros and Cons of Hiring an Independent Contractor