Hiring Direct and Contract Employees for Your Small Business

by on June 13, 2013

When it comes to hiring employees for your small business, there are really two paths that you can follow.  You can hire a direct employee that works for and gets paid directly from your company.  Or, you can hire a contract employee that you pay as a contractor.  Here are some of the pros and cons of hiring each type of employee.

Hiring a Direct Employee for Your Small Business

Hiring a real employee that actually works for you company is a big deal.  Not only do you take on the full responsibilities of that employee, but you are also responsible for setting up payroll, paying a share of the income taxes, and depending on the laws and the size of your business, sharing in part of the health care costs and other benefits.

All of these costs can dramatically increase the cost of hiring an employee.  You should plan on spending about 25% more than the employee’s base pay on these other taxes and administrative costs.  The 25% is a rule of thumb that we use at my company, although the actual cost is probably in the range of 15-35%, depending on the level of benefits you provide.  In addition to these costs, your taxes will be more complicated and you will have to spend extra time on things such as payroll setup and legal changes that affect employees in your area.  You can outsource a lot of these tasks to ADP or other companies, but then your cost will likely go up even more.  These types of employees have to be reported on form W-2’s.

So now you’re probably wondering what the advantages are of hiring a direct employee.  Well, there are actually quite a few.  For one, you get better control over your employee, since they are directly employed by you.  Second, and more important, you offer your employee a more stable work environment and better benefits than paying them by contract.  And finally, you may qualify for more tax breaks and subsidy programs for small businesses.  Your employee retention rate should also be higher with these types of hires.

One last negative about direct employees is that they are harder to get rid of.  If you need to terminate a direct employee you may be responsible for certain benefits, and be held to state and federal laws about how to do it.  Also, it is easier for the terminated employee to file a lawsuit in these cases.  If you want to learn more about this, you can get free tips on hiring employees from a number of sources including other websites and your local or state agencies.

Hiring a Contract Employee for Your Small Business

The other option for hiring a small business employee is to hire a contract employee.  Contract employees are paid a set dollar amount, usually per hour, and their pay does not include any benefits or other direct costs.  These types of employees are paid using 1099 tax forms.  The cost is deducted as a business expense on your taxes and you are not responsible for providing benefits such as social security and tax withholdings.The main benefit of hiring a contract employee is that it is simple, requires very little paperwork, and you know upfront how much their wages are going to cost you.  Also, if you are unsure of how long you will need the employee, it is easier to terminate the contract rather than a regular employee.

Some contract employees are hired through staffing agencies, where the staffing agency charges you a set amount and does all the benefits and tax withholdings.  For these purposes, we are referring to hiring employees directly and not that type of contract employee.  For example, the website industry employs contract employees very frequently.  Web designers, bloggers, and other social media and online advertising agencies often prefer this type of employee.  In fact, technically, these are not really employees but rather someone you hire to perform a service.

The downside to using 1099s and contracts to hire employees is that it can be more expenssive.  That’s because these types of employees still have to pay for their healthcare and taxes from the money you pay them.  A typical contract rate is usually 30-50% more than that person’s base wages would be for the same job if he or she was an employee.

In summary, it’s a good thing to know the pros and cons of hiring contract or direct employees for your small business before you make the decision.  Being educated is always the best way to make any decision.


{ 2 comments… read them below or add one }

Best Umbrella Company July 26, 2013 at 3:20 am

If the company hiring the direct employee the cost will be high and the employee payroll calculated as a permanent employee and in case of contract employee staffing is done by agency and its for an temporary period which is cheaper as per the company’s point of view.


Payroll Services August 1, 2013 at 3:04 am

Contract employees work for businesses on a project basis and may control how, when and where they work. A direct hire employee performs services for a business and has no control over the details of how those services are performed and last but not the least if we considering the small business i think it will be highly beneficial for them.


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