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Should I Hire Employees or Independent Contractors?

How-to


As your firm grows, you will need to expand your team. It could be because you have more clients and you need more designers. Or it could be that you’re drowning in paperwork and you need someone to handle bookkeeping. I have even known super successful designers whose first hire was a marketing guru to handle their social media. Whomever you decide you need, and it’s specific to YOUR business, you’re facing two options: hiring employees or hiring independent contractors.

Many businesses choose to hire employees and hire independent contractors because both have their pros and cons. When looking for local talent and company loyalty, you might choose to hire a full-time employee. When looking for flexibility and expertise, a business owner might choose to hire a contract worker. To help you figure out whether you should hire employees or independent contractors when growing your business, we’ll explain how the two differ. We’ll identify advantages and disadvantages of hiring employees and compare those to the pros and cons of hiring independent contractors. At the end, we will briefly outline the penalties for misclassifying workers – I know, HR isn’t so cut and dry! Follow below to learn more!

How to Know When It’s Time to Expand Your Team

Expanding your business is an exciting time. You’re building the foundation for future growth. Plus, now you’ll have someone else to vent to when a tough client comes in! However, hiring new workers can be expensive and should be carefully considered. Here are a few signs it might be time to build out your team in 2022:

#1 You Spend Too Much Time on Minor Tasks

The first sign that it might be time to hire new workers is that you spend too much valuable time on minor tasks. In a recent post on the Design Dash blog, we underscore the importance of delegating when expanding a business. As a business owner, your time is better spent managing high-level elements of the business than engaging in menial administrative tasks. Once you get big enough, you’ll probably want to expand beyond your design staff. Hiring an accountant is essential for invoicing, paying vendors, and also taking care of your monthly sales tax obligations. We have in-house accounting at Laura U Design Collective because with 40 active clients, accounting is a full-time job!

#2 Your Clients Can Tell the Business is Struggling to Meet Demand

If your clients can tell that the business is struggling to meet demand, it might be time to hire. The resource “​​When to Hire More Employees: 4 Signs It’s Time to Expand Your Workforce” from ADP explains.

According to ADP, “an insufficient workforce can result in customers falling through the cracks.” It could also lead to “the loss of prospective customers whose inquiries go unacknowledged.” Given that “no business can afford to alienate existing customers or neglect potential new ones,” you might want to expand your team. Days can get so busy that even answering the phone is impossible. And those missed calls could be missed opportunities. At Laura U, we have an office manager to handle incoming calls. We also have a dedicated procurement team that can manage product questions and troubleshooting.

#3 Your Current Employees Are Unhappy and Overworked

Work-life balance is incredibly important to retaining workers. In a recent post, we note that “‘long working hours are bad for one’s health, with adverse effects on cardiovascular and mental health.’”

Failing to prioritize your team’s health and happiness could not only hurt them. It could also cause them to seek employment elsewhere. If your current employees are unhappy and overworked, it might be time to build out the team. And as a firm owner, you’re probably burnt out, which is why you’re hiring!

#4 Your Business Has Expanded into New Markets

If your business has expanded into new markets, it might require workers with different skill sets than your existing team. When this happens, it might be time to hire. In her article “How to Know When to Hire Additional Staff” from The Houston Chronicle, Holly McGurgan explains.

McGurgan writes that “current employees might not have the skills your company needs if you plan to offer a new product or service.” You could choose to retrain your team, but it might make more sense to hire workers who are already skilled in those areas.

#5 All That Overtime Pay Is Getting Too Expensive

Under the Federal Fair Labor Standards Act of 1938, employers are required to pay full-time employees overtime if their work week exceeds forty hours. Overtime is not an optional part of your employee benefits package, but rather a requirement of federal law.

If team members are working overtime, you must pay them time-and-a-half for the hours that exceed a typical work week. This can get incredibly expensive and is usually not the most economical choice. Hiring new workers might be your best bet.

Employees Vs Independent Contractors

But what sets independent contractors, freelancers and gig workers apart from employees? The IRS differentiates independent contractors from employees based on the amount of control workers have over their time and work product. In her article “When to Hire a Full-Time Employee vs. Contractor” for Business.com, Skye Schooley explains. Schooley writes that “the three categories the IRS uses to classify [workers] are behavior, financing and relationship type.”

Unlike employees, independent contractors have a lot of freedom in the way they behave. From taking on new clients to balancing dozens of projects, IC’s can manage their business as they please. In some states, it is actually illegal to impose a non-compete contract on a freelancer.

Independent contractors also have financial freedom from employers. According to “The Pros and Cons of Hiring an Employee vs. a Contractor” from Indeed.com, businesses control elements of their employees’ financial picture. Employers control “their paycheck, bonuses, stock options and reimbursement for expenses.” Freelancers determine their rates, how they are paid and how often they are paid.

The last way in which independent contractors differ from employees is “relational.” Employers are required by federal and state law to respect rights relegated specifically to employees. These include paying minimum wage or above, providing workers compensation insurance and more. Employees might also receive voluntary benefits like life insurance, extended maternity leave or retirement plans. These benefits are laid out in a contract that demonstrates the “employer-employee relationship.”

All About Independent Contractors

Independent contractors have become a major force in the business world. In the article “Are Companies Too Reliant on Independent Contractors?” for the Society for Human Resource Management (SHRM), David S. Fortney underscores this. Fortney writes that “modern independent workforce has become an engine of economic growth, providing increased benefits…to the companies utilizing independent contractors.”

They help businesses realize both long-term and short-term goals — often while saving costs and resources. According to Fortney, independent contractors are crucial to “developing or improving products and services.” They are also vital to “increasing speed to market, meeting market demands, increasing organizational agility, and achieving sustainability goals and decreasing carbon footprints.” Below, we identify a few of the pros and cons of working with independent contractors.

Is There a Difference Between Freelancers, Gig Workers and Independent Contractors?

The IRS does not distinguish between freelancers, gig workers and independent contractors. However, these three terms cannot always be used interchangeably. According to this post from the QuickBooks blog, “a freelancer is similar to an independent contractor.” The post notes freelancers “tend to work on a project-to-project basis and have multiple employers at the same time.”

Most “independent contractors will be on long-term contracts.” On the other hand, “freelancers are usually hired on short-term contracts.” Independent contractors are more likely to be involved in realizing the long-term goals of their clients in addition to realizing their short-term goals. Freelancers are usually less integrated into the company’s operations and less familiar with the team.

Both must set aside tax funds, but contractors typically register their business “as a sole proprietorship or corporation.” Freelancers might not register as a business. Some states dictate how and when freelancers must classify themselves as independent contracts and register as a business. A gig worker could be either a freelancer or independent contractor.

As Colorado-based attorney Aiden Durham notes in this video for her YouTube channel, these are “all different ways for saying ‘not an employee.'” From a legal perspective, there is no functional difference between independent contractors, gig workers and freelancers. Each is an independent worker.

Can You Make an Independent Contractor Sign a Non-Compete?

In many states, it is illegal to require an independent contractor to sign a non-compete contract. For example, non-competes have been illegal in California for quite a while. In Texas — where one of our LUDC offices is located — non-competes are enforceable. They are enforceable under certain conditions in Colorado — where our other office is located — but the state is weighing changes to their laws.

Even in states like Texas and Colorado where requiring an IC to sign a non-compete is legal, there are restrictions. According to Colorado-based Hansen Law Firm, businesses can establish non-competes. However, they must be able “to prove that the restrictions imposed by the agreement are reasonable.” To determine if restrictions are reasonable, a court will consider duration and “geographic scope of the restriction.” They will also consider “whether the agreement is overly restrictive” and has damaged the IC’s business.

Plus, non-compete could complicate the independent contractor’s status as a freelancer. In his 2021 post “When Can Non-Competition Agreements Be Enforced Against Independent Contractors?” for employment law firm Carey & Associates, P.C., Chris Avcollie explains. Avcollie writes that “when an employer imposes non-competition restrictions on an independent contractor, it runs the risk of changing the nature of its relationship.” The non-compete gives the employer a greater degree of control over the IC.

Freedom and independence from employer control is one of the defining characteristics the IRS assigns to contractors. In short, “imposing a non-competition agreement could be construed as evidence of the very control that marks a traditional employment relationship.” If the contractor sues, they could be entitled to lost wages and/or employment benefits.

Instead of risking a misclassification lawsuit, employers might consider another type of agreement. For example, a non-disclosure agreement protects their trade secrets but does not inhibit the IC’s freedoms.

Pros and Cons of Hiring an Independent Contractor

There are many benefits to hiring an independent contractor. Hiring IC’s could help you fill roles faster and offer a greater degree of flexibility to your business. Freelancers could help you build a more diverse team without requiring lots of training. Plus, the responsibilities you have towards contract workers are minimal.

All you need to do is pay invoices as they are sent to your accounting department and send a 1099 in January. You are not responsible for the contractor’s tax obligations, nor are you required to pay out any benefits. Not having to pay for your portion of the IC’s taxes could result in payroll savings of 20 to 30%!

Your liability is also less when working with an IC. According to this post from Indeed.com, “hiring an independent contractor allows the employer to set the terms of their employment relationship.” This can “greatly reduce their liability if a claim is made against them.” There are some exceptions, of course. If an IC injuries themself at a job site, they could sue their employer for damages. They might be entitled to medical bills and subsequent loss of work.

Another potential issue with hiring an IC is that you might not automatically own the work they produce. In his article “Pros and Cons of Hiring Independent Contractors” for NOLO, Stephen Fishman, J.D. explains. Fishman writes that you might “hire an IC to create a work that can be copyrighted — such as an article, book, or photograph.” However, you might not be automatically “considered the owner of the work.” You might have to “use a written agreement transferring copyright ownership from the IC to you.” The opposite is true of employees.

Here are a few more pros and cons of hiring an independent contractor instead of an employee.

Pro: You Could Spend Less Money and Fewer Resources

Con: Independent Contractors Might Not Be Available When You Need Them

Pro: Independent Contractors Provide More Flexibility

Con: Your Right to Fire Might Be Restricted

Pro: You Incur Less Liability When Working With a Freelancer

Con: You Might Not Automatically Own the Rights to Work Created for Your Business

Pro: Freelancers Have Specific Skill Sets and Require Less Training

Con: Contractor Workers Are Less Tuned-In to Your Company’s Culture and Values

Pro: Hiring Independent Contractors Could Help You Build a More Diverse Team

Con: You Could Get in Legal Trouble If You Misclassify

When an Independent Contractor Might Be Best for Your Business

If your business needs a specialist or a seasonal worker, an independent contractor might be the right fit for you. In her article “Hiring Contract vs. Full-Time Workers: Which Is Better for Your Business?” for NerdWallet, Meredith Turtis explains. Turtis writes that an IC might be the “more cost-effective choice for your business…during particularly busy times.”

Staffing flexibility is a key benefit of hiring IC’s over employees. They might also be the right choice during expansions. When growing your business, offerings might become more complex or diverse and experts in different specialties might be needed.

All About Employees

Pros and Cons of Hiring an Employee

There are also many pros and cons to hiring an employee. Employers are required by law to treat employees in a certain manner. They must pay at least minimum wage, contribute to the employee’s tax burden and provide coverage in case of injury or illness. To remain competitive, employers might also need to offer benefits like health insurance, paid maternity leave, unlimited PTO, retirement accounts and more. Though employees might be more expensive to retain than IC’s, they offer incredible value.

First, you will be able to exert more control over your employees. For example, you will automatically own the rights to work product created by employees in most states. You will also be able to determine which hours they work, where they work and which projects they work on. Second, employees are more invested in preserving company culture and values. They tend to be more loyal to businesses than IC’s. Third, employees regularly interact with other team members. This can increase cohesion and consistency.

Pro: Commitment to Company Culture and Values

Con: Employees Might Be More Expensive to Retain

Pro: Consistency and Control

Con: Full-Time Employees Could Be More Difficult to Replace

Pro: There Are Many Tax Deductions for Wages Paid and Employee Benefits

Con: Businesses Have a Responsibility to Help Employees Grow in Their Careers

Pro: Employees Regularly Interact With Other Team Members

Con: Business Owners Must Follow Regulations Related to Employment Taxes, Benefits, Workers Compensation Insurance and More

When an Employee Might Be Best for Your Business

If preserving company culture, values and relationships is most important to you and your team, hiring an employee might be the best choice. In her article “Contract Workers vs. Employees: What Your Business Needs to Know” for Business News Daily, Jennifer Post explains. Quoting Kimberly Schneiderman, Post writes that “companies work to make sure full-time employees are engaged and work to gain loyalty.” Contractors on the other hand “are always looking for the next gig.” They are not as “invested in long-term outcomes as full-time employees are expected to be.”

You might also consider an employee if you want to control work hours, output and resource consumption. In “​​Which Should I Hire—Employee or Contract Worker?” for The Balance, Jean Murray identifies a couple other reasons to hire an employee. Murray writes that an employee might be best if you have a “long-term need.” They might also be the best if “this work is essential to your business and not a peripheral job.”

Penalties for Misclassification of Employees as Independent Contractors

Earlier in this post, we briefly mentioned that business owners can get into serious legal trouble if they misclassify employees as independent contractors. One of the reasons lawyers dissuade business owners from sending non-competes to IC’s is that they could end up reclassifying them. Misclassification could result in an audit and/or lawsuit.

In her article “Contract Workers vs. Employees: What Your Business Needs to Know” for Business News Daily, Jennifer Post explains. Post writes that misclassification will require a company to “‘pay back taxes as well as fines and penalties.'” These penalties are “‘based on the number of IRS Form W-2s that the company failed to file…and a percentage of wages.'” Though rare, “businesses could face criminal penalties” in extreme cases.

Classification Rules in Texas and Colorado

Whether you could be sued for misclassification depends on the classification tests used by both your state government and the federal government. At the Laura U Design Collective, our team works in both Aspen, Colorado Houston, Texas. Here are laws specific to those states to give you an idea of how regulations differ from one area to the next. States like Texas rely on the IRS’ classification of independent contractors vs employees and the DOL’s worker classification rules. They do not provide additional parameters or restrictions.

Other states — like California — are very strict and are more likely to reclassify IC’s as employees than states like Texas. They use ABC tests in addition to the IRS’ test. In her article “Independent Contractor Laws and Regulations: What Employers Need to Know” for The Balance, Jean Murray explains. Murray writes that the ABC test is “a more restrictive worker classification test.”

ABC tests determine workers to be employees unless they meet three specific criteria at the same time. To qualify as an IC, the worker must be “free from control and direction of the hiring entity.” They must also “perform work outside the entity’s usual course of business.” Third, IC’s must be “engaged in an independent trade, occupation, or business of the same nature as the work performed for the hiring entity.”

Colorado falls somewhere in between. The state of Colorado uses a variation on the IRS’s common law test. Business owners should keep in mind that whenever there is a mismatch between federal and state law, one must follow the stricter regulations.

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Laura Umansky

I'm Laura

As an inerior design business owner, I understand how challenging this industry can be and how hard it is to find success. For the past 15 years, I have grown my award-winning firm from a party of one (just me!) to a talented team of over 20, with two brick-and-mortar studios. And through it all I experienced set backs and the loneliness that comes with being an entrepreneur. That’s why I’m sharing all my tips and tricks on the blog. Success shouldn’t be a secret. Find your reliable path to sustainable, profitable growth right here.

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