When a business has a need that requires a new hire, the question of hiring a contractor vs. an employee will probably be put on the table at some point. There are benefits and drawbacks to each, both in terms of performance and accounting.

When making the decision to hire one or the other, there are several things to take into consideration. First and foremost, make sure you understand the differences between a contractor and an employee. Secondly, assess your needs and determine whether they’ll require a long-term personnel solution or if it’s a temporary challenge. And, lastly, understand your tax obligations for each.

First, let’s take a look at the differences between a contractor vs. an employee.

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What Makes a Contractor?

When you’re looking at the contractor vs. employee question, it’s important to understand the differences.

Essentially, a contractor is somebody who is in business for themselves. That is, they are their own business. They promote themselves and their services, and are not beholden to your company.

According to the IRS, “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work, not what will be done and how it will be done. Small businesses should consider all evidence of the degree of control and independence in the employer/worker relationship.”

Contractors generally work for companies on a temporary basis, often having a defined end date for their services. Of course, some perform ongoing work without a definitive termination, but they’re still employed as-needed for a finite period of time.

Employees, on the other hand, are brought into the company with no end-date in mind. They’re hired to work towards the company’s goals on a basis that is assumed to be ongoing.

Maryland Tax Requirements for Employees and Contractors

Taxes are one of the areas where we see a major divergence in how employees and contractors are handled.

If you hire an employee, you are required to withhold portions of that person’s wages for income taxes and their share of employment taxes. You’re also obligated to remit those withholdings to the government on a regular basis. Then, on top of that, you must pay a share of the employee’s employment taxes. There are also some situations where you’ll be required to pay into a worker’s compensation fund along with additional unemployment taxes.

In the case of independent contractors, you’re not responsible for any of their taxes. Instead, you simply file an IRS Form 1099, and the IRS will use your provided information to make sure the contractor is paying their taxes on what they earned.

So, in terms of tax requirements at least, a contractor is much less work on your part, and less of an investment as well.

Unfortunately, a lot of companies have misclassified their employees as contractors to get around paying their share of taxes. In 2016, Maryland placed sanctions on the intentional misclassification of contractors vs. employees that could cost a company a lot of money if they’re found guilty of it.

If the Maryland Secretary of the Department of Labor, Licensing and Regulation (DLLR) finds that an employer hasn’t properly classified a worker as an employee, they’ll issue an assessment for delinquent unemployment contribution payments. If the employer fails to pay that assessment within 45 days, they’ll be charged 2% interest per month beginning with the first due date after the notice of misclassification.

As you can imagine, that could lead to a lot of money.

Additionally, if the DLLR finds that the employer knowingly misclassified their employee(s), the employer will be subject to a civil penalty of up to $5,000 for each employee. If the employer is a repeat offender, that penalty could jump to $10,000 per employee.

The IRS Also Penalizes Misclassification

It’s not just the state of Maryland that will penalize a business if they misclassify their employees. The IRS will also hand down some pretty hefty punishment.

If the IRS determines that a business has misclassified an employee, they might impose some heavy penalties on that employer including, but not limited to, a $50 fine for every W-2 the employer failed to file for a misclassified employee, a penalty of up to 3% of the wages, plus up to 40% of the FICA taxes that were not withheld from the employee and up to 100% of the matching FICA taxes that should have been paid by the employer.

So, in short, make sure you’re classifying your contractors vs. employees to the best of your knowledge, or you’ll be paying a lot of extra money in penalties down the road.

How to Choose – Contractor or Employee?

When it comes time to actually decide whether you want to bring on a temporary contractor or hire an employee, there are a few things you should consider.

First, what is the problem/need that this person is being brought in to solve? Is it something that will be ongoing, like customer service? If so, you’ll probably want to hire an employee. On the other hand, if it’s something like a need for a redesign of your website, a contractor might be more prudent.

Secondly, it’s important to consider the amount of control you want to have. Employees are more integrated with company goals. They’re using company equipment most of the time, and they’re beholden to company values. Contractors work independently and as a separate entity from your company.

Lastly, think about cost. Will having an employee save you money and help you meet a continuous need down the road? If not, consider hiring a contractor. You can always contact them again for their services should a similar need arise in the future.

How KatzAbosch Can Help

Tax planning and preparation should never be just a once-a-year activity. Maximize the financial resources available to your business as it grows. Our advisors monitor the ever-changing rules of the tax environment to help you manage tax risk and opportunities as it relates to your business situation. To learn more on how KatzAbosch can help determine if a contractor is a good fit for your situation contact us today.

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