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Contractor or Employee? How Your Business Set-Up Determines Your Taxes

IMG_8311If you're setting up a new business, you need to determine whether or not you want to treat your new hires as employees or as contractors when it comes to taxes. You'll often hear the advice that paying taxes on employees is overwhelming and that contract work will save you on tax, but there are reasons that you may want to consider both sides before making the final decision. "The number of independent contractors has risen in sectors that people normally don't associate that closely with the self-employed," according to Michelle Walker, business writer and independent contractor. Before you jump on the band wagon, though, there are some factors to consider.

The Cost of Hiring Employees

If you hire employees, you'll have to pay a part of their Social Security and Medicare taxes along with state unemployment insurance and workers' comp insurance. This means an extra 15-35 percent on top of your already existing payroll.

Why Hire an Employee, Then?

If the cost is so much higher, why would you hire an employee? Well, if you have a specific way and time you want an employee to do a job, you'll want to hire them as an employee rather than as an independent contractor. Another reason you'll want to hire an employee over a contractor is to ensure their loyalty to your business. An independent contractor isn't required to be loyal to your company and can seek out work with competitors in the same market while employees can be asked to sign non-compete contracts that keep them from offering services to competitors.

When Is It Best to Hire Contractors?

Sometimes, though not all the time, contractors will work from their space and use their own equipment. If you want to hire someone to blog or copyedit or even design content for your company, you can easily hire an independent contractor to do this from their own computers in their own workspace. This saves you money on equipment and workspace and allows your contractor more freedom as well. Other reduced costs associated with independent contractors include reduced payroll costs associated with health insurance and tax costs.

The Downside of Hiring Contractors

In spite of lowered tax costs when it comes to payroll, there are some downsides to hiring contractors. The setup of 1099s and other allowances for taxes and contractors can be time-consuming. This could mean that you might be spending your time and energy or paying your accountant extra to get everything set up. You will also have to work with the financial demands of your contractors. If their costs go up, yours will too. You may also find it's difficult to manage poor independent contractors. Let's say you hire someone for a job but they don't deliver. You don't have as much leverage when it comes to ensuring timely and effective work.

Initially, there are many tax benefits for employers to hire independent contractors rather than employees, but there are trade-offs when it comes to control and time spent. Before deciding which way is best for you, make sure that you map out your tax requirements with your accountant. Or if you're managing your own books, take some time to compare the costs and benefits of each structure

Author Mary Vollmer is an independent contractor. When it comes to taxation of her income she uses an accounting company. Check the web for several accounting company options such as

Photos courtesy of:  Luigi