When your small business needs an employee vs. a contractor

When it comes to the bottom line, employment decisions are crucial for small businesses. One big one is how to staff up when your business is growing. For many small business owners it’s a question of when to hire an employee, and when a contractor is a better option. It's an important distinction, and one with financial implications. Here's some insight to help assess your needs, and determine which type of worker may be the more appropriate choice.

Make sure the cost will bring in revenue

The Bureau of Labor Statistics estimates that employers spent about $35.87 per hour per employee in total compensation in 2017.1 But it's also a matter of calculating what an employee would contribute. “Consider if the cost [of an employee] will bring in revenue, and when that revenue will come,” explains Tom Wheelwright, CEO of Tax-Free Wealth CPAs in Arizona.

If a law firm hires a lawyer, they'll be producing revenue immediately. If they hire an administrative person, the only way they produce revenue is to free up someone else's time to produce revenue. “The mistake people make is they go, 'I'm busy, therefore I need somebody,'” Wheelwright says. “You only need somebody if bringing them on produces more revenue than not having them.”

Understand how long and how often you need them

If this is short-term need you don't need to put someone on payroll. Forty hours a week for a couple months still qualifies as a short term, so a contractor is an ideal pick for a one-time project (like updating your company website or designing a brochure) or seasonal work (like retail help over the holiday season).

If it's a longer-term need, but not one that requires a lot of hours, a contractor likely makes more sense. For instance, many small businesses often hire an outside accountant to do their taxes and consult on a quarterly basis.

Know what the IRS says

A contractor typically costs more per hour, but if you use that worker less, he can be less expensive than an employee—plus, you aren't responsible for their benefits or taxes.

The government has a variety of tests to determine whether that person you're employing qualifies as an independent contractor.2 Two primary tests are:

  • Will you have control over where and when this person does the work you need them to do?
  • Is this person able to offer her service to other businesses while she also works for you?

“If I'm going to hire a receptionist who's going to sit in my office, and be paid by the hour, she's going to have to be an employee because I control when and where she performs her work," says Steven Weil, Ph.D., president and tax manager of RMS Accounting in Florida. On the other hand, if you utilize an answering service to answer your calls from their location—and the calls of other companies—that could be an outside contractor.

Before making a move one way or the other, consult with your accountant or legal advisor to help you decide which option is the best fit—and most tax compliant—for your firm, and to understand the resulting tax and financial implications of each option.

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