Businesses are hiring contract workers at a record rate to help with all aspects of the business. Despite increasing regulations on contractors and freelancers, a tight labor market is giving individuals the opportunity to showcase their expertise exactly where they want. A recent Gusto study shows that in the last two years contractor payments have risen 23%, and the ratio of contractors per employee is now nearly 1-to-5. Contract workers have the freedom to choose who they work for, on mutual terms, and with more flexibility than traditional employment arrangements, which is why it’s become an increasingly more desirable option.
Many small business owners choose to hire contract workers for various reasons, but they aren’t exactly sure about the process for hiring and accounting for contractors, or the possible disadvantages that come with contract workers. Below you will find the ins and outs of hiring contractors, as well as some resources intended to be helpful to small business owners.
What is the difference between traditional and contract workers?
In order to stay in compliance with all rules and regulations pertaining to employment arrangements, it’s vital to understand the differences between employees and contractors as a small business owner. When hiring contractors, you will need to have contractor agreements that differ materially from your traditional employee agreements. Working with a lawyer who specializes in these types of agreements will ensure you have covered all of your bases.
The differentiating factor comes down to the type of agreement and how taxes are paid. If you have an employee, you will need to withhold applicable payroll taxes which the business will pay. If you have a contract worker, the business does not withhold any taxes; all pay goes directly to the contractor, who is then responsible for paying his or her own taxes. There are also rules about the ways you manage contract workers.
For more details to help you understand the differences between employees and contractors, visit our blog here to review examples and other identifying factors.
What are the advantages and disadvantages of hiring contract workers?
Like anything, there are always advantages and disadvantages to various types of employment arrangements. Hiring contract workers can offer many benefits, especially for small business owners or organizations in a period of growth. Larger businesses, on the other hand, may benefit more from hiring traditional employees. For our purposes, we will focus on the advantages and disadvantages from a small business perspective.
Advantages
Below are a few common advantages and reasons you may hire a contractor or freelancer:
- At the beginning stages of a business when the budget is tight and there might not be the need for a full-time staff employee, a contract worker might be a great option.
- Contract workers typically offer their services in a variety of arrangements, including full-time, part-time, and even on an as-needed basis.
- You may find it more cost-effective to work with an expert who has more experience in a given field than you would be able to afford as a full-time hire.
- You need help ASAP and don’t have time for the lengthy process of hiring a staff employee. Hiring contractors can be a simpler, more cost-effective, and less time-consuming process than hiring employees.
- Contract workers often work virtually, giving you access to industry expertise from virtually anywhere. This removes the geographical boundaries of the talent pool. For ultra-niche businesses, this may be the key to your business’s success.
Disadvantages
There may be a few disadvantages of hiring contract workers as a small business owner:
- Contract workers might not be totally invested in your business.
- You have less control due to the type of arrangement.
- Short-term arrangements may lead to poor integration and less teamwork.
It is important to note that we often find these disadvantages can be easily mitigated by finding the right fit for your business. Not everyone will be the right fit, just as not every employee will be the right fit. Do your due diligence, ask for references, be comfortable and confident in the agreement between the contract worker and the business, and keep an open line of communication.
And don’t forget, you get what you pay for. It may be tempting to work with someone offering budget rates, but will that in return hold the business back? A good contractor should add value to your business and be well worth the investment. Keep in mind when reviewing contractors’ rates that you will not be responsible for certain other expenses associated with W-2 employees, including payroll taxes and employee benefits. Contractor payments are also tax deductible, so be sure to keep proper documentation.
What documents does a business need to collect from a contract worker?
Although you do not need to file a traditional W-2 as you do with an employee, you will need to collect a W-9 in order to provide the contract worker and IRS a 1099 at tax time. Our number one recommendation is to collect a W-9 from each contractor at the beginning of the working relationship. This will ensure that you aren’t left in a scramble come tax season. The W-9 includes the vital information needed to report the contractor’s earnings to both the contractor and IRS via Form 1099. If you are utilizing a cloud-accounting payroll app, such as Gusto, you can securely collect, and store this information in the cloud during the onboarding process.
Aside from the W-9, you will also need an agreement signed by both parties that details the terms for both sides (your business and the contractor’s). Your specific business, industry, or state may also require additional documentation.
How to account for contract workers
Depending on the agreement with your contract worker, you will receive periodic invoices from the contractor for services rendered. Common arrangements include a monthly report of hours worked; recurring retainer fees; project-based invoices; and fixed service plans. If you are using a cloud accounting app, you can set up invoices to be sent directly into your accounting system.
The good news is that paying contractors does qualify as a deductible business expense. This means that the amount you pay contractors or freelancers can reduce your overall tax liability. We recommend you review our comprehensive guide to small business tax deductions to identify qualifying expenses, some of which you may be missing.
A Gusto study reported that 67% of contractors say they would not prefer a traditional employee arrangement over their current contract arrangements. Contract workers enjoy the flexibility, and ability to work with those who value their expertise. Has your business enlisted the help of a contractor? If you’ve been curious as to how a contract worker could add value to your growing business but aren’t sure how to integrate them into your back office, send our team a message. We can help you establish back-office protocols and accounting tools to make the process seamless.