contractors vs. employees

A lot of young companies struggle with the idea of contracting additional help or hiring full time employees. On one hand you are really excited that you have so much work you need to bring on more staff but at the same time the idea of payroll, benefits, withholding tax and other full-time employee administrative requirements are quite daunting to the ‘little guy’ starting out. I have witnessed many start-ups that immediately go to contracting individuals and sometimes end up in a wee bit of trouble - mostly with the Canada Revenue Agency (”CRA”) or the Internal Revenue Service (”IRS”).

Ideally, yes, there is something to be said for contracting in the early days:

• less commitment - which in a world of extreme contraction and expansion is a good thing. You may need them this week, but maybe not next. Remember, cash management is key.
• they bear the burden of covering their own tax responsibilities meaning you don’t have to withhold income tax, pay a share of their pension or unemployment insurance or remit to the government. They simply invoice and you pay like any other vendor.
• you don’t have to provide benefits and pay their pension contributions - benefits administration is quite time consuming.
• it gives you time to ‘try them out’ before extending a full time offer.

Remember, though, that with consultants you are paying a premium for this flexibility so try to use consultants strategically so you get the most bang for your buck. As well, part of what makes a contractor independent is their ability to choose how the work is performed. Yes, they bring special skills to the table as ‘hired guns’ but their loyalties reside with themselves. So, make sure to be clear on the what, when and where of the deliverables.

And before proceeding with any employment relationship check the government fine print first and make sure you include the exact same wording in your contract with the individual to make sure you are covered. Misclassified relationships have extreme penalties if the government audits you and finds you have determined one status when another was more accurate.

For instance, in Canada you need to verify if the individual is truly a self-employed individual or employee. CRA provides a checklist to help determine an individuals status and confirm the relationship (either “employer-employee relationship” or “business relationship”). To further protect yourself, I advise my clients to include the following in their contracts with independent contractors:

You confirm that you are a ’self-employed individual’ as defined by the Canada Revenue Agency and therefore no deductions will be made at source. You will charge GST and other taxes as are applicable and will invoice accordingly.

In the United States, the IRS provides a checklist to determine whether the individual is: an independent contractor, an employee (common-law employee), a statutory employee or a statutory non-employee. Again, I advise my clients to include the following in their independent contractor agreements:

You confirm that you are an ‘independent contractor’ as defined by the Internal Revenue Service and therefore no deductions will be made at source. You confirm you are responsible for your tax obligations and will act accordingly.

In either country the ‘independent’ nature is usually determined by the degree of control and independence over the work. Just make sure you have checked before you proceed. Like I said: misclassifications are costly.

Having said all this - how exciting that you need more help! Things must be taking off for you. Yeah!