Hiring Independent Contractors vs. Employees

Small business owners wear many hats. As your business grows and expands, it’s important to hand off some of your duties and responsibilities to others.

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Sometimes, that means hiring part or full-time employees. But in other cases, you might only need some extra help for a specific or short-term project. In those situations, hiring independent contractors (ICs)—also known as 1099s—can help you fill open roles and delegate responsibilities without a lengthy or expensive onboarding process.

But there are rules, benefits, and disadvantages to hiring a 1099 employee. Let’s look at who ICs are, why you should consider hiring (or not hiring) one, the differences between independent contractors and employees, and how to hire contractors to fulfill your small business’s needs.

What Is an Independent Contractor?

The Internal Revenue Service (IRS) defines an independent contractor as someone who is self-employed and hired to do a job for someone else. This includes:

Lawyers
Accountants
Contractors and subcontractors
Graphic designers
Programmers/software engineers
Writers

Independent contractors work on a contractual basis. That means their employment lasts only as long as the contract remains in force.

Additionally, independent contractors are responsible for their own expenses, including taxes and training, and aren’t entitled to overtime pay or the other benefits you provide to employees.

Independent Contractors vs. Employees

Ultimately, what determines a worker’s classification depends on your overall relationship and the degree of control you exercise (or have the right to exercise). The more control you exert over how, when, and where a worker performs their job, the more likely it is the IRS will classify them as an employee. In contrast, a worker with more freedom to decide how, when, and where they work will likely be classified as a contractor.

The IRS weighs different factors in determining if a worker is a contractor or employee:

Behavior: If you control or have the right to control what workers do and how they do their job.
Finances: If you control how business aspects of the worker’s job are handled, such as pay and reimbursement, and if you provide necessary tools and supplies.
The type of working relationship: If the worker is under contract, receives benefits, works continually, and is performing work that is a key aspect of your business.

The Department of Labor (DOL) uses similar characteristics to determine whether a worker should be classified as an IC or an employee. These factors include:

If the worker operates their own business
How the worker is paid
If tools and supplies are provided by you
If the worker works for you alone or has multiple clients or customers
How long the relationship is intended to last (ongoing vs. ending upon the completion of a project)
How and when the work is performed
If tasks are assigned or the worker decides what to work on

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It’s important to note that whether someone should be classified as an IC or an employee isn’t black and white and is more dependent on the specific circumstances.

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That being said, there are situations that typically lean more towards IC or employee classification, including:

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Independent Contractor vs. Employee

Independent Contractor	Employee
Controls what work is done and when it’s submitted	Assigned tasks and deadlines by a manager
Uses their own equipment	Uses company equipment
Works on sporadic or short-term projects	Works regularly and/or on long-term projects
Has multiple clients	Only works for your business
Submits an invoice	Uses company time-tracking systems
Receives no benefits	Receives benefits
Works whatever hours they’d like	Required to work specific dates and times
Files Form 1099-NEC	Files Form W-2

Benefits and Drawbacks of Hiring Independent Contractors

In many cases, hiring independent contractors can benefit your small business, though there are also drawbacks to consider before you make a decision.

Pros

Low cost: The cost of hiring a new employee is $4,700, which includes advertising for an open role, holding interviews, processing background checks, training, and providing necessary equipment. You’re also responsible for the cost of employee benefits, unemployment insurance, workers’ compensation, payroll taxes, and other expenses. In contrast, independent contractors cost an average of 30% less than employees—which means you can find the support you need without breaking your budget.
Faster onboarding: It typically takes three months to onboard new hires. Because independent contractors work on a much more limited basis, it’s quicker and easier to outline your expectations and get them up to speed with the information they need to perform their work and finish a project. For example, since independent contractors generally use their own equipment, you won’t need to offer training on how to use your in-office computers.
Flexibility: With some exceptions—like layoffs, terminations, and moving on to other jobs—part-time and full-time employees are hired on a long-term and continuous basis. On the other hand, ICs are hired on an as-needed basis for short-term work, giving you the flexibility to fill labor gaps without lengthy commitments.
Less legal liability: Employees are protected by state and federal labor laws that penalize employers for noncompliance. Because ICs aren’t protected by most employment laws, your business is less exposed to employment-related litigation, like allegations of wrongful termination or failure to pay the minimum wage.

Cons

Less control: For the most part, ICs work autonomously and independently. You’re limited in your ability to dictate how and when work is performed, which means ICs have leeway to set their own deadlines and turnaround times, follow their own processes, and use the tools and equipment of their choice.
Increased risk: Hiring an IC may expose you to potential risks like intellectual property theft and stolen trade secrets (since you’re potentially sharing sensitive company information with someone outside of your organization) or an increased risk of government audits (since companies often misclassify employees as ICs). Additionally, if you misclassify a new hire as a 1099 when they should actually be an employee, it can lead to significant financial issues, including tax obligations, back pay, and increased insurance premiums or claims. (More on that later.)
Limited buy-in: ICs work with multiple clients. This can result in limited—or nonexistent—loyalty to your company and its projects and can make it difficult to retain the same worker over a long period.
Reliability: Because you lack control over many of an IC’s processes, it can be challenging to ensure the IC adheres to deadlines or finishes an assigned project. ICs might move on from your contract with little to no warning, unexpectedly leaving you with unfinished—and potentially late—work.
Contractual obligations: IC agreements and contracts can limit you from taking certain actions—or penalize you for doing so. For example, you might have to pay a substantial fee for terminating a contract prematurely.

When to Hire Independent Contractors vs. Employees

There’s no one right choice between hiring employees or ICs. It makes sense to hire independent contractors over employees when the work:

Isn’t a core part of your business: For example, a plumbing company might hire an IT technician as a contractor to take care of the office’s computers and networking equipment.
Is a highly specialized short-term project: ICs can perform work you’re unable or unwilling to do, such as preparing your taxes (in which case you’d hire a CPA).
Doesn’t fit into your workload: ICs can take on work that you can’t fit into your schedule, such as a virtual assistant responsible for handling simple and repetitive tasks like data entry, scheduling, and other light administrative duties.

When filling an open role, make sure you don’t misclassify an employee as an IC—or vice versa. Misclassification—even if it’s accidental—can result in substantial fines and penalties from your state’s department of labor and the IRS.

You could also be on the hook for unpaid overtime wages, retirement contributions, and benefits, as well as a potential lawsuit. Work with your human resources department (or outsource to an HR specialist) to ensure you’re properly classifying your workers.

How to Hire Independent Contractors

Now that you know what roles ICs serve in relation to your small business, let’s look at what steps you should take when hiring a contract worker.

1. Determine What You Need to Hire For

Before you can hire independent contractors, you need to identify what roles they need to fill—and to what extent. This can help you avoid hiring an IC when an employee would be a better fit. It also helps you determine the size and location of your talent pool.

In general, if you’re hiring for a role that is short-term, sporadic, or tied to specific projects, hiring an IC could make sense.

When to Hire an Independent Contractor vs. Employee

Consider an Independent Contractor for:	Consider an Employee for:
A specific type of project	Multiple projects that have a broad scope
Short-term work	Indefinite work
Flexible work that can be done anywhere, anytime, and at the worker’s leisure	Work that needs to be performed at a specific location and/or during a specific time frame
Work that only needs to be completed sporadically	Work that needs to be completed on a regular/daily basis
Work that can be completed using independent equipment	Work that needs to be completed on your own systems/using your own equipment (for example, computers)
Projects that can be started quickly, easily, and with minimal training or onboarding	Work that requires a significant investment in training and onboarding

2. Create an Independent Contractor Agreement

An independent contractor agreement is a legal document that outlines the working relationship between your business and an IC. This should be a written contract that defines the:

Relationship: Recognition that you and the contractor are not entering into an employer-employee relationship.
Project scope: What work or services the contractor is being hired to perform or produce, including deliverables, milestones, constraints, and acceptance criteria.
Payment terms: How you will pay the IC, as well as when the IC can expect payment. Other payment-related information—such as late payments and kill fees—should also be included.
Contract length: How long the contract will remain in force and the criteria for extending the contract or terminating it early.
Intellectual property and ownership: Who owns the completed work and any associated copyright. You can also grant or restrict the contractor from including completed work in a portfolio and specify if they receive credit for their work.
Confidentiality: Outlines how sensitive information, trade secrets, and other proprietary information is handled. These requirements might also be outlined in a non-disclosure agreement (NDA) that requires one or both parties to treat elements of the relationship—or the relationship entirely—as confidential.
Indemnification: A clause that protects your company from liability if a contractor’s work results in a claim of negligence or breach of contract.
Governing law: The state or country that dictates which laws apply in the event of a dispute.
Other obligations: If you require that a contractor maintains active licenses or insurance as a prerequisite for doing business. You might also require a non-compete or non-solicitation clause that restricts the contractor from working with competitors or poaching your clients.
Tax responsibilities: Specifies that the IC is solely responsible for any tax liabilities associated with payments they’ve received from your company, and that your company isn’t responsible for any tax withholdings or other obligations on behalf of the IC.

3. Find the Right Freelancer

Once you’ve outlined the specifics of who you’re looking for, start searching for contractors and freelancers by:

Posting the position on relevant job boards: Typical resources include Indeed, LinkedIn, and Upwork, as well as local job boards, Facebook, and other industry-specific platforms—for example, ConstructionJobs.com for the construction industry.
Asking for referrals: Leverage your existing staff and relationships with customers and clients to ask for word-of-mouth recommendations.
Requiring work samples or portfolios: Review samples of a contractor’s past work to determine if it compares to the type and quality of work you’re looking for.
Looking at reviews and testimonials: Ask an applicant to provide reviews and testimonials from past clients speaking to their performance and quality.
Holding a discovery interview: Schedule a call or meeting with an applicant to ask questions about their experience and skills and determine if they meet the needs of your business.
Verifying credentials: If you need to hire a licensed contractor, ask for their license number to verify its authenticity and status. This helps ensure they’re legally permitted to perform the work.

4. Get Your Paperwork in Order

When you hire an independent contractor, ask for a completed Form W-9. A W-9 is similar to an employee’s W-4 and should include the contractor’s name, address, and taxpayer identification number (either a Social Security number or employer identification number).

(If the contractor is a foreign citizen, they will have to fill out Form W-8 BEN instead.)

Because ICs are responsible for paying self-employment taxes, income taxes, and Medicare taxes, make sure they exempt themselves from tax withholding.

When tax season rolls around, use the information included on Form W-9 to fill out a Form 1099-NEC for any contractor you paid $600 or more in the given tax year. Then, send one copy to the IRS and one to the contractor by January 31 (or the next Monday if the 31st falls on the weekend). State laws might also require you to file a copy with your state tax department.

The IRS requires you to retain a copy of Form W-9 for at least four years. Additionally, you should also store copies of your contractors’ insurance policies, licenses, invoices, receipts, and contracts.

5. Figure out Your Payment Process

Unlike employees—who you pay consistently and uniformly—contractors vary in terms of payment preferences and processes. Payment factors to consider include:

The type of compensation: If you want or agree to pay contractors by the hour, per milestone, or upon completion of a project.
How often you pay: The basis on which you pay your contractors, such as when you process payroll for employees, upon receipt of an invoice, bi-weekly, monthly, or at the conclusion of a project.
How you pay: If you pay by check, direct deposit, through a payment processor, or via wire transfer.

Remember that you’re not responsible for withholding taxes on behalf of any contractors you hire. However, you are responsible for invoicing and bookkeeping, so figure out a system—or work with an accountant or bookkeeper—to manage your records and stay on top of your finances and independent contractor payments.

6. Onboard Your Independent Contractor

Onboarding a freelancer or gig worker is less complex than welcoming a new employee to your team. Still, both parties can benefit by undergoing some form of onboarding.

Start by setting up an initial post-contract meeting to familiarize the contractor with your team. Go over your paperwork to clarify any confusion or iron out any pending details. During this time, rehash your expectations and introduce the contractor to your processes and any tools or software they’ll need to use to get their job done.

If necessary, provide the contractor with any necessary training before the project begins.

7. Provide Ongoing Support

Hiring ICs is step one of the process—but once on board, you need to make sure to maintain open lines of communication and provide ongoing support.

Checking in with your freelancers on a regular basis can help you identify potential issues that the contractor might not be aware of (like sending texts when your company prefers emails). It also gives you insight into the quality of the contractor’s work and can help you gauge the likelihood of meeting deadlines.

Additionally, ongoing communication helps build rapport between you and your ICs. Nurturing this relationship can make the IC more invested in your business and the success of the project, as well as more likely to work with you in the future or on a longer-term basis—potentially even becoming a full-time employee if the opportunity and need arise.

At the end of a contract, offer feedback and ask for feedback in return. If the experience was positive, consider extending the contract or mention getting in touch in the future to hire the contractor again.

FAQs About Hiring Independent Contractors

Still have questions about hiring contract workers vs. employees? Let’s look at some frequently asked questions.

How Do I Set Up a 1099 Employee?

Setting up a new 1099 requires a completed Form W-9 (or Form W-8 BEN for foreign citizens), which includes the worker’s name, address, and tax ID number. You can then provide this information to your payroll service provider.

If you pay a 1099 worker $600 or more in a given tax year, you are required to fill out a Form 1099-NEC. Copies of the completed tax form must be filed with the IRS and sent to the contractor by January 31.

What Paperwork Is Needed for a 1099 Employee?

You are required to collect a completed Form W-9 (or Form W-8 BEN for foreign citizens) from a 1099 employee. This information is necessary for processing Form 1099-NEC at the end of the tax year. You should also require a written contract and copies of the worker’s license, insurance policy, invoices, and receipts, as necessary.

Is It Better to Be a 1099 Employee or a W-2 Worker?

1099 employees can exercise a larger degree of freedom in the workplace, though this often comes with the trade-off of less stable income and additional challenges, like having to continually look for new clients and projects. On the flip side, W-2 employees enjoy more consistent employment, but have less freedom to decide how and when they work.

Independent Contractors Can Help You Scale

Hiring new employees is costly. For special, unexpected, or one-off projects, it often makes more sense to hire an expert on a limited basis than it does to recruit, hire, and onboard a new employee. Using freelancers and gig workers can help you fill open roles quickly, letting you meet demand and grow your business–without the expense of adding team members.

Successfully bringing an independent contractor on board boils down to having a clear process for finding, hiring, and training them. And now that you know how to create those processes, all that’s left to do? Get out there and find the 1099s you need to take your business to the next level.

Remembering Shay Litvak Our Co-Founder and CTO

Hiring Independent Contractors vs. Employees

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