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Employees vs Contractors: The Accounting Considerations

There are many important differences between an employee and an independent contractor that can affect the financial foundation of your business. Continue reading to learn some of the financial impacts you should consider when making this decision.

     In nearly every business, there comes a time when you need help to reach the next level of success. When that time comes, which should you hire: an employee or an independent contractor? There are many important differences between the two that can affect the financial foundation of your business. The table below explains some of the financial impacts you can consider when making this decision.

Employee Contractor
Taxes Employers must withhold income taxes, Social Security, and Medicare from an employee’s wages. Contractors handle their own income and self-employment taxes.
Benefits Employers may have to provide paid vacation, holiday, and sick days to full-time employees. Businesses don’t have to provide paid time off for contractors.
Insurance Employers may have to purchase workers’ compensation insurance and pay unemployment insurance taxes. Businesses don’t have to purchase workers’ compensation or pay unemployment taxes on independent contractors.

Based on the table above, it may seem as though hiring an independent contractor is the way to go. However, the IRS has rules about who can be treated as an independent contractor and penalizes businesses that misclassify workers.

Deciding whether your new hire is an employee or an independent contractor involves three areas:

  1. Behavioral control. An employer has the right to direct work performed by an employee. However, a business owner cannot control how an independent contractor works, only the desired results.
  2. Financial control. An employer can mandate that an employee not have a second job or start a competing side business. Independent contractors are free to work for other clients and seek out other business opportunities.
  3. Relationship. How do the employer and worker perceive their relationship? It’s helpful to have a written contract stating the worker is an independent contractor.
  4. Legal aspects aside, which is better: employee or contractor? The following questions may help you decide:

Do you need long-term or short-term help?

If you need help with a short-term project, a contractor may be a better fit. For example, if you need help building your website but won’t have much need for a web developer once the site is up and running, that’s a good project for a contractor. The short-term nature of contract work ensures you only pay for the time and services you need.

Is the work an essential part of your core product or service?

Contractors are great for doing work that supports your business but isn’t part of your core business activities or skills. For example, you might outsource website development to a contractor but hire an employee to handle customer service.

It's important to do what is best for your business, and there can be a lot of decisions like this one that can be challenging. If you don’t know where to start, you don’t have to handle it alone. When you work with KPMG Spark, our professionals reconcile your books and help you when you're faced with business decisions. We also facilitate access to payroll management, prepare tax filings and provide a dedicated bookkeeper and CPA. With our help, your financial foundation will meet your needs so you can focus on other key areas of your business.

The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG LLP.

This blog article is not intended to address or provide advice concerning the specific circumstances of any particular individual or entity and does not constitute an endorsement of any entity or its products or services.

Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.

The following information is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

KPMG SparkSeptember 22, 2021Posted In: Business Tips

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