Subcontractor Or Employee? Make Sure You Know the Difference

Business owners value agility perhaps more than any other quality in managing their operations. As the word implies, a business is agile when it’s quick on its feet, flexible, and able to adapt to rapidly changing conditions. And nowhere is agility more crucial than when it comes to staffing your business to weather the ever-cyclical surges and downturns that challenge most small businesses.

Subcontractor or EmployeeTaking on the services of an independent contractor offers some very real advantages when the needs of a project or a client become too great or too specialized for your hired workers to handle. But be careful – in the eyes of the IRS, a contractor is not a contractor just because you say he is, and your business could be on the hook for taxes and other expenses that you would pay, or pay for, a normal employee.

Why think about subcontracting some of your work? For one thing, the cost savings realized by paying a subcontractor for the same work that you could get done “in house” can be 25% and more. You save on taxes (Social Security and Medicare), insurances (worker’s compensation, liability), and benefits (vacations, retirement plans, training, etc.), costs that are borne not by you, but by the business entity providing your business with the service in question. Second, a subcontract relationship can allow you to take on work that would overwhelm your payroll employees. You can subcontract for the duration of a project, and simply end the arrangement when the work is done. And third, subcontracting may enable you to bring in specialized workers for work that your company normally wouldn’t or couldn’t perform, thus beginning a relationship with a new client that you might otherwise have had to forego.

That said, plenty of businesses have hired “subcontractors”, only to find that in effect they have hired employees, and owe overtime pay, benefits, back taxes, interest, and penalties, which all told is sometimes enough to drive them out of business. Even a scrupulous, well-meaning business owner can get tangled in a snarl of issues regarding the employee vs. subcontractor question.

The problem is that the business/subcontractor relationship is judged on numerous criteria and tests, and all together these add up to some very subjective rulings. The U.S. Supreme Court has said that there is no single factor that determines whether a worker is indeed an independent contractor or an employee. The IRS, for its part, breaks the criteria for examining the relationship into three main categories:

Behavioral – does the company control how, where, when, and in what sequence the worker will perform the work? Will the worker use tools, equipment, and materials provided by the company? Does the company train the worker to do the work?

Financial – is the worker paid hourly or weekly, or in a lump sum for the entire project? Does the worker have expenses and investment that could cause him to lose money in doing the work? Does the worker make his services available to others besides the company, i.e., to the general public?

Type of Relationship – is there a written, signed contract between the parties? Is the relationship considered by either the company or the worker to be permanent? Is the work performed by the worker a key aspect of the company’s business?

This is just a representative sampling of the questions and tests that can be used in determining the nature of the relationship between a business and its workers; for a more detailed explanation, visit the IRS webpage that addresses the employee-subcontractor issue. The U.S. Small Business Administration also offers a more in-depth, supportive resource that examines the question at their site. Subcontractors can help your business immensely – just make sure that it’s a subcontractor you’re getting!

About Lauren Messing

Lauren Messing is Marketing Specialist for Madico Window Films. She can be reached at lmessing@madico.com.
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