Working With Independent Contractors

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Introduction

There are many benefits to hiring ICs, but there are serious risks as well. No book can tell you whether you should use ICs in your business, but this chapter will help you make an informed decision by summarizing the potential advantages and disadvantages.
Benefits of Using Independent Contractors

It can cost less to use ICs instead of employees because you don't have to pay employment taxes and various other employee expenses for ICs. In addition, you will be less vulnerable to some kinds of lawsuits. Perhaps most importantly, hiring ICs gives you greater flexibility to expand and contract your workforce as needed.
Financial Savings

It usually costs more to hire employees than ICs because, in addition to employee salaries or other compensation, you will have to pay a number of employee expenses. These expenses add at least 20% to 30% to your payroll costs, often more. For example, if you pay an employee $10 per hour, you must pay an additional $2 to $3 or more per hour in employee expenses.

You incur none of these expenses when you hire an IC. Even though ICs are often paid more per hour than employees doing the same work, you will still save money in the long run by using ICs.

In addition to the costs of payroll processing, the most common employee expenses include:

* federal payroll taxes
* unemployment compensation insurance
* workers' compensation insurance
* office space and equipment, and
* employee benefits such as paid vacation and health insurance.

Federal Payroll Taxes

Employers must withhold and pay federal payroll taxes for employees. They must pay a 7.65% SocialSecurity tax and a small-usually 0.8%-federal unemployment tax out of their own pockets. In addition, employers must withhold Social Security taxes and federal income taxes from their employees' paychecks, and periodically hand this money over to the IRS. (See Chapter 3.)

In contrast, you don't have to withhold or pay any federal payroll taxes for ICs. This will help you save money, not only in taxes, but in bookkeeping costs as well.
Unemployment Compensation

Employers in every state are required to contribute to a state unemployment insurance fund on behalf of most employees. The unemployment tax rate is usually somewhere between 2% and 5% of employee wages, up to a maximum amount set by state law. (See Chapter 5 for more on unemployment compensation rules.)
Workers' Compensation Insurance

Employers must provide workers' compensation insurance coverage for most types of employees, to provide some wage replacement and reimbursement of medical bills if an employee is injured on the job. Employers can get workers' compensation insurance either from private insurers or state workers' compensation funds. Premiums can range from a few hundred dollars per year to thousands, depending upon the employee's occupation and a company's claims history. Employers don't have to carry workers' compensation insurance for ICs. (See Chapter 6 for information about state workers' compensation laws.)
Office Space and Equipment

Employers typically provide their employees with workspace and whatever equipment they need to do their jobs. This is not necessary for ICs, who ordinarily provide their own workplaces and equipment. Office space is usually an employer's second biggest expense; only employee salaries and benefits cost more.
Employee Benefits

Although not required by law, employers usually provide their employees with benefits such as health insurance, paid vacations, sick leave, retirement benefits, and life or disability insurance. You need not-and should not-provide ICs with such benefits.

Health insurance costs, in particular, can be enormous. Many employers are cutting back on health insurance benefits for employees in attempts to save money. But these kinds of cutbacks can have high costs in employee discontent.
Reduced Exposure to Lawsuits

When you hire employees, you may be subject to some types of legal claims that ICs can't make against you.
Labor and Antidiscrimination Laws

Employees have a wide array of rights under state and federal labor and antidiscrimination laws. Among other things, these laws:

* impose a minimum wage and require many employees to be paid time-and-a-half for overtime
* make it illegal for employers to discriminate against employees on the basis of race, religion, gender, national origin, age, and disability
* protect employees who wish to unionize, and
* make it unlawful for employers to knowingly hire illegal aliens.

In recent years, a growing number of employees have brought lawsuits against employers alleging violations of these laws. Some employers have had to pay hefty damages to their employees. In addition, various watchdog agencies, such as the U.S. Department of Labor and the U.S. Equal Employment Opportunity Commission, have authority to take administrative or court action against employers who violate these laws.

Few of these antidiscrimination and employment laws apply to ICs, so you have much less exposure to these kinds of employee claims and lawsuits when you use ICs instead of employees. (See Chapter 8.)
Wrongful Termination Liability

Employees can also sue for wrongful termination. In these legal actions, an employee claims that his or her firing was illegal or constitutes a breach of contract. Wrongful termination laws vary from state to state. Under some circumstances, for example, it might be a breach of contract for you to fire an employee without good cause. To guard against wrongful termination claims, employers must carefully document the reasons for firing an employee, so they can defend their actions in court, if necessary.

ICs cannot bring wrongful termination lawsuits. However, there usually are contractual restrictions on when you can fire an IC. For example, your contract might state that you can fire an IC only with written notice, or only for failing to meet his or her obligations under the contract. If you disregard these limits, you could face a breach of contract lawsuit.