It can cost less to use ICs instead of employees because you don’t have to pay employment taxes and various other employee expenses. In addition, you will be less vulnerable to some kinds of lawsuits. Perhaps most importantly, however, hiring ICs gives hiring firms greater flexibility in expanding and contracting the workforce.
1. Financial Savings
It usually costs more to hire employees than ICs because, in addition to employee salaries or other compensation, you usually have to pay a number of employee expenses. These expenses add at least 20% to 30% to your payroll costs, often more. For example, if you pay an employee $10 per hour, you must pay an additional $2 to $3 or more per hour in employee expenses.
You incur none of these expenses when you hire an IC. Even though ICs are often paid more per hour than employees doing the same work, you can still save money by adding them to your workforce.
In addition to the costs of payroll processing, the most common employee expenses include:
- federal payroll taxes
- unemployment compensation insurance
- workers’ compensation insurance
- office space and equipment, and
- employee benefits such as vacation and health insurance.
a. Federal payroll taxes
Employers must withhold and pay federal payroll taxes for employees. They must pay a 7.65% Social Security tax and a small—usually .08%—federal unemployment tax out of their own pockets. Employees’ own Social Security taxes and federal income taxes must also be withheld from their paychecks by their employers and paid to the IRS.
No federal payroll taxes need be withheld or paid for ICs. This not only saves hiring firms money, but accounting and bookkeeping costs as well.
b. Unemployment compensation
Employers in every state are required to contribute to a state unemployment insurance fund on behalf of most types of employees. The unemployment tax rate is usually somewhere between 2% to 5% of employee wages—up to the maximum amount of wages that are taxable under the state’s unemployment compensation law.
c. Workers’ compensation insurance
Employers must provide workers’ compensation insurance coverage for most types of employees in case the employees become injured on the job. Workers’ compensation insurance is obtained from either private insurers or state workers’ compensation funds. Premiums can range from a few hundred dollars per year to thousands, depending upon the employee’s occupation and a company’s claims history. Workers’ compensation insurance need not be provided for ICs.
d. Office space and equipment
Employers normally provide their employees with workspace and whatever equipment they need to do the job. This is not necessary for ICs, who normally provide their own workplaces and equipment. Office space is usually a hiring firm’s second biggest expense; only employee salaries and benefits cost more.
e. Employee benefits
Although not required by law, employers usually provide their employees with benefits such as health insurance, paid vacations, sick leave, retirement benefits and life or disability insurance. You need not and should not provide ICs with such benefits.
Health insurance costs, in particular, can be enormous. Many employers are cutting back on health insurance benefits for employees in attempts to save money. But these kinds of cutbacks can have high costs in employee discontent.
2. Reduced Exposure to Lawsuits
When you hire employees, you may be subject to some types of lawsuits for which you aren’t liable when you hire ICs.
a. Labor and anti-discrimination laws
Employees have a wide array of rights under state and federal labor and anti-discrimination laws. Among other things, these laws:
- impose a minimum wage and require many employees to be paid time-and-a-half for overtime
- make it illegal for employers to discriminate against employees on the basis of race, color, religion, gender and national origin
- protect employees who wish to unionize, and
- make it unlawful for employers to knowingly hire illegal aliens.
In recent years, a growing number of employees have brought lawsuits against employers alleging violations of these laws. Some employers have had to pay hefty damages to their employees. In addition, various watchdog agencies, such as the U.S. Department of Labor and the U.S. Equal Employment Opportunity Commission, have authority to take administrative or court action against employers they claim have violated these laws.
Few of these anti-discrimination and employment laws apply to ICs. So you have much less exposure to these kinds of employee claims and lawsuits when you have ICs as workers.
b. Wrongful termination liability
Another type of lawsuit employees can potentially file against you is for wrongful termination. In these legal actions, an employee claims that his or her firing was illegal or constitutes a breach of contract. Wrongful termination laws vary from state to state. Under some circumstances, for example, it might be a breach of contract for you to fire an employee without good cause. To guard against wrongful termination claims, hiring firms must carefully document the reasons for firing an employee.
ICs are not employees and so cannot bring wrongful termination lawsuits. However, there usually are contractual restrictions on when you can fire an IC.
c. Liability for workers’ actions
When you hire an employee, you’re liable for anything he or she does within the scope of employment. For example, if an employee gets into an auto accident while making a delivery, you may be liable for the damages.
Subject to several important exceptions, this is not the case with ICs. You are not liable for an IC’s actions, work-related or not, unless:
- the IC you hired was not qualified to do the job and you were negligent in hiring him or her
- an injury occurs because you gave the IC bad directions
- you know the IC is violating the law in working for you—for example, you hire an unlicensed IC to perform work that requires a construction contractor license, or
- you hire an IC to do work that is inherently dangerous—for example, building demolition.
3. Flexibility in Hiring
What is most important for many hiring firms is that working with ICs provides a level of flexibility that can’t be obtained with employees. An IC can be hired to accomplish a specific task and then forgotten, enabling a business to obtain specialized expertise for a short period. You need not go through the trauma and potential severance costs and lawsuits brought on by laying off or firing an employee. And an experienced IC can usually be productive immediately, eliminating the time and expense involved in training employees. By using ICs, you can expand and contract your workforce as needed, quickly and inexpensively.