How to Decide What’s Right (and Legal) for Your NC Business
The decisions to be made when starting a new business in North Carolina, or when the time comes to scale up your business, can be daunting. One of the most important decisions for small business owners to make is “Should I Hire an Independent Contractor or an Employee?”
Indeed, the personnel you hire and the classification they fall under carries significant consequences for businesses. This article outlines the differences between contractors and employees, and discusses the advantages and disadvantages of hiring each.
Who is an Employee in North Carolina?
In order to answer the question “Should I Hire an Independent Contractor or an Employee?”, we should first understand who is categorized as an employee in North Carolina. Legally, an “employee” is a person who works in the service of another under an express or implied contract of hire, under which the employer has the right to control the details of the employee’s work performance.
The biggest advantage of hiring an employee is that you, the employer, get to completely control that person’s work during work time, train the person in the way you want the job done, and require that person to work only for you. There are few restrictions or limitations on the work you can assign to the employee.
On the other hand, the primary disadvantage in hiring employees is that there are myriad laws and regulations that businesses must follow for employees. Both the federal government and the State of North Carolina regulate the payment of wages and/or salaries, overtime, and other work rules. In North Carolina, the law governing an employee’s wages and/or salary is called the North Carolina Wage and Hour Act.
There are also tax consequences to hiring employees. Business with employees must pay payroll taxes, which includes paying half of the FICA taxes (i.e. Social Security and Medicare) for each employee. The other half of FICA taxes is collected from the employee. Other responsibilities for businesses with employees include payment of unemployment insurance and worker’s compensation insurance.
Who is an Independent Contractor in North Carolina?
The advantages and disadvantages of hiring independent contractors are essentially the opposite of those for employees.
The primary benefit to utilizing independent contractors is that you have few tax responsibilities. You must report the amount you have paid each independent contractor using Form 1099-MISC, but you there are no tax withholding requirements, nor do you have to pay FICA taxes on these payments. Accordingly, businesses that utilize independent contractors have significantly fewer payroll responsibilities than a business that hires employees. Additionally, businesses who use independent contractors have fewer obligations with respect to wages and/or salaries and overtime. For example, in North Carolina, independent contractors do not fall within the protections of the North Carolina Wage and Hour Act.
In terms of disadvantages independent contractors have much more freedom in how and when the work is done. While you may impose a deadline and assign tasks, you generally cannot control how the independent contractor does the job. In addition, an independent contractor can work for others, can often set his or her hours of work, and often provides his or her own material or tools.
When Should I Hire an Employee for My NC Business?
Based upon the above differences, your business should consider hiring an employee if:
- The work needs to be done under your supervision and control;
- You want to control the hours of work and the means through which the work is accomplished;
- If the worker is to fill a long-term need; or
- If this work is essential to your business
In situations where you need to exercise a maximum degree of control over the worker, should you probably hire an employee. Simply put, a business cannot exercise much control over an independent contractor, and utilizing a contractor in situations where such a degree of control over the time, means, and supervision of the work may lead to a situation where you need to exercise control, but can’t.
In addition to the above, it is appropriate to hire an employee if your business has grown to the point where it can support the additional requirements that come with having employees, such as the tax consequences and other federal and state regulations imposed on businesses who hire employees. Doing so before the business can support these additional obligations could lead to a situation where the business cannot financially pay the required taxes or insurance, leading to preventable financial and legal woes.
When to Consider Hiring an Independent Contractor in NC
Your business should consider utilizing independent contractors if:
- The work is not central to your business;
- The work can be done by someone who does not need much supervision over their work; or
- The work is a short-term project that will be completed in a defined period of time
If you do not need to exercise as much control over the work being done, or if the work is only on a temporary basis, then you should probably hire an independent contractor. Given that hiring employees carries significant obligations under federal and state law, using independent contractors for short-term work allows your business to use workers to complete the project without having to take on any responsibilities for taxes or insurance, which increases costs and paperwork. Essentially, independent contractors are often a more efficient option for business owners to use for temporary work or work that can be done with less oversight than traditional employees.
Properly Classifying Workers as Employees or Independent Contractors
Although you may want to classify workers as independent contractors, it is very important to be aware of how the Internal Revenue Service analyzes worker classifications for tax purposes. Because businesses do not need to pay taxes for independent contractors, the IRS treats this classification very seriously–it can be very tempting to misclassify employees as independent contractors for this very reason.
The IRS uses a three-part analysis to determine whether a worker is an employee or an independent contractor (regardless of how the business itself classifies the worker). It looks quite similar to the factors already discussed above:
- Behavioral: Does the business control or have the right to control what the worker does and how the worker does his or her job? If a business provides training for the worker, for example, this signals that the business expects the worker will follow guidelines received in training and is therefore likely an employee.
- Financial: Are the business aspects of the worker’s job controlled by the payer? (For example, how the worker is paid, whether expenses are reimbursed, who provides tools and supplies, etc.). Employees cannot reap profits or suffer financial losses from their work, but independent contractors can.
- Type of Relationship: Are there written contracts or employee-type benefits (For example, a pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?
The burden is on the business itself to show that there is a reasonable basis to classify a worker as an independent contractor in order to escape the burden of paying taxes. Misclassification of workers carries serious consequences—across the country, employees misclassified as independent contractors have won lawsuits against their former companies, receiving back wages, overtime pay, and other benefits.
Additionally, misclassification can result in significant fines from the U.S. Department of Labor, the IRS or state governments. In North Carolina, employees who believe they have been misclassified as independent contractors may, under the North Carolina Wage and Hour Act, report the suspected misclassification to the Employee Classification Section of the North Carolina Industrial Commission, which works with various state agencies to enforce applicable North Carolina employee classification laws.
Final Answer: Should I Hire an Independent Contractor or an Employee?
If you are wondering if you should hire an employee or an independent contractor, it’s a good idea to speak with an experienced NC Business Law attorney who can listen to your needs and concerns and advise you on which option is best for your company and situation. This attorney will also be able to draft documents required for the decision you make such as employment agreements, non-competes when necessary, and agreements with independent contractors.