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by Jen Leigh on October 31, 2018

6 of Your Most Pressing Independent Contractor vs. Employee Questions Answered

The numbers tell the story: Today in the United States, one in every five workers is a contract employee. This "gig economy" is growing, too. A study from Princeton shows that the percentage of freelancers like contractors increased from 10.1 percent in 2005 to 15.8 percent in 2015, and economists believe that by the time we hit 2030, they will outnumber regular employees. Do you have a cloud-based payroll solution to handle this?

Certainly, the tactic of staffing up with independent contractors has much to recommend it: Hiring in this manner means you can have a just-in-time workforce. As such, you'll typically save money, as you're only paying the workers you need when you need them, not carrying them on the payroll, and since you're not incurring the same amount of overhead as you would with an employee.

Additionally, working with contractors allows you to be more flexible and responsive with your workforce, adjusting your numbers depending on demand. Finally, you'll also dramatically reduce training expenses or do away with them entirely, since contractors are subject-matter or skillset experts.

It's a pretty compelling value proposition, the idea of creating a workforce out of independent contractors … until, that is, you consider the myriad regulations regulating your interactions with these workers. Before you jump on the bandwagon with the trend toward independent contractors, let's run through a few of the most commonly asked questions about hiring this type of worker, and how to know when you should hire an employee instead.

Why can't I just make everyone an independent contractor? Why should I even hire employees?

First off, the IRS makes a legal distinction between independent contractors and employees based on a number of different factors: the amount of control you have over the worker and the how they do the work you've given them; the existence of a written contract between you and the worker; whether your arrangement is ongoing; and whether or not you provide benefits for the worker. While it could be possible to have an employee on a 1099 and a W2, the logistics involved are difficult to keep standard.

If you misclassify a worker, you could end up with a tax liability on your hands, and the potential also exists that you could find yourself liable for costs like back pay for overtime. Being clear on the difference between the two classifications will ensure that you stay on the right side of government regulations and out of the path of an audit. 

Payroll Problems? Is it time to make the case for change?

However, there are many reasons - aside from the obvious legal ones - to go with employees. You have complete control over their work process, and you don't have to scramble looking for help when you need it, because they're already there. Often, the hourly wage for employees is less than that for contractors - you give them job security and they work for a slightly lower scale. Your current payroll can give you a case for change; keeping employees can reduce payroll errors compared to keeping on contractors.

Finally, should it occur that you have to be out of the office for any length of time, you'll have the confidence of knowing that your staff can handle the business in your stead.

Can I scale my business using independent contractors?

In fact, businesses in a growth phase represent a very common source of work for independent contractors. If you're an entrepreneur or running a small company, you know the pain of having to wear too many hats at one time. You'll get to the point where it is simply not a cost-effective use of your time to dispatch certain responsibilities, and you need to delegate.

Contractors can be a terrific resource at this point - you can bring in a pair of hands to take care of those functions that you just don't have time for, freeing you up to do the critical work of the company. Obviously, having a dramatic seasonality to your business is another scenario in which contractors can be a big plus.

Best of all, you have no long-term obligation to the contractor, so if the demand that had you stretched too thin abates, you can reassume your former responsibilities and economize. If demand continues to grow, you can make the determination as to how to proceed: make a job offer to the contractor or hire an employee in their place.

What is the Gladwell-esque "tipping point" between hiring one versus the other?

Yes, this can be simply a matter of taking all the pros and cons of both approaches into consideration when you're ready to hire - but there's also a mathematical rule of thumb you can apply to the decision.

Generally speaking, independent contractors eat into your profit margin more than employees because you're paying them at a higher rate to compensate for the lack of job security in this type of role. Therefore, looking at this decision from the cold, hard, scientific standpoint of an economist, which way you go is dependent mainly on your profit margin.

If you're sustaining a profit margin of at least 50 percent, and your employees are operating at least 85 percent efficiency (85 percent of their time is billable), then this is a good time to consider adding another person to the payroll as an employee. If your metrics are below these marks, look in the direction of contractors instead.

If I hire both, is there a good ratio?

Many successful businesses use a mixed workforce model in order to get the best of both possible worlds - the loyalty and all-hands-on-deck stability of permanent employees plus the flexibility independent contractors. This is a best-case scenario for many companies, assuming you have workers in both classes deployed properly and can manage all the HR complexities.

The correct ratio for you will likely depend on key metrics like profitability plus the particular demands of your business - like seasonality. Generally speaking, however, an 80-20 ratio is a good place to start, with 80 percent of your workforce made up of permanent employees and 20 percent flexible workers. The right payroll processing system can easily bring these analytics up so a decision can be made.

What are the disadvantages of hiring only independent contractors?

Since the amount of control you have over him or her is a primary determinant of whether a worker is classified as an employee or a contractor, the amount of control - or, better said, lack thereof - that you have over a contractor is probably the easiest drawback to pinpoint when it comes to flexible staffing. The measure of the success of a contractor is in their work product, not how they get it done. Be prepared to divorce yourself from the process, because the contractor is running his or her own business rather than acting as an engaged employee.

Other disadvantages include lack of loyalty, lack of consistency - you can't depend on getting the same contractor every time you hire for a job, so there may be many different sets of hands or approaches affecting your work - and that, except in very rare cases, contractors are not going to promote your company since they're there representing their own interests.

Finally, the contractor will own all copyrights he or she generates in working for you, unless you draft an agreement specifically stating otherwise.

What's the simplest way to determine the difference between an independent contractor and an employee?

The rule of thumb for evaluating this distinction, as approved by the IRS, is the Common Law Test. According to this metric, a worker is an employee if you, the employer, have complete control over what they do and how they should get it done. If you only have control over the result of the work done, the person performing that work is an independent contractor.

Still confused? The Social Security Administration provides in-depth guidelines on the subject.

As an employer, contractors can offer you a much-needed boost of productivity without the significant capital outlay associated with employees. However, don't pass up the opportunity to hire full-time staff if it makes sense for your business. The added collegiality and loyalty you'll get from employees who are in the trenches with you, as well as the additional brand ambassadors you'll gain, can make the extra expenditure so worthwhile.

Regardless, ensure that you're fully aware of the difference in classifications - and if you're confused about any phase of balancing out your workforce, we at Inflection HR have all the knowledge you need to serve as a guide.

CTA Payroll Solution Guide

Jen Leigh

Jen Leigh is a Senior Product Specialist with Inflection HR's Cloud Based HR and Workforce Management Solutions. Connect with Jenni and the rest of the Inflection HR Team on Twitter, Facebook, or LinkedIn.