Running your business as a sole proprietorship with the assistance of independent contractors rather than employees has many advantages – all of which allow you to allocate more time and money to your business. However, there are drawbacks to using independent contractors that, depending on your business needs, may outweigh the advantages.
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Flexibility With Contractors
Since you can hire contractors by the hour, with no guarantee of future work, you have the flexibility to frequently re-evaluate your labor needs and choose to work alone when business conditions make it practical to do so rather than paying employees for the entire year. And during periods your business is thriving, you can quickly hire additional contractors for short-term projects. However, you need to remember that contractors have the same flexibility, which in some cases can be to your disadvantage if they find higher paying work and fail to provide the services your business needs. Employees tend to be more reliable and generally provide employers with advance notice of their temporary absences and resignations.
Contractor Tax Advantages
Hiring independent contractors rather than employees can save you a significant amount of money on employment-related taxes. The Internal Revenue Service, as well as many states, requires sole proprietors to withhold income tax from their employees’ paychecks, to pay federal unemployment tax and to pay a portion of each employee’s Social Security and Medicare tax bill. You can, however, avoid these taxes and the related compliance obligations by hiring independent contractors instead. Independent contractors pay their own Social Security and Medicare taxes, aren’t covered by the federal unemployment program and aren’t subject to income tax withholding in most cases. Another benefit of using contractors is that you can eliminate the cost of obtaining workers' compensation insurance -- which provides employees, but not contractors, with compensation for their work-related injuries.
Cost of Employee Benefits
The cost of hiring employees for your sole proprietorship can end up costing much more than just the wages and salaries you pay. For many businesses, attracting and retaining talented employees requires a compensation package that includes a number of common benefits. These benefits typically include employer subsidized health and dental insurance, contributions to retirement accounts, life insurance, tuition reimbursement and an array of others that can increase the overall cost of labor for sole proprietors significantly. In contrast, independent contractors generally don’t expect similar benefits and require only payment for the services provided.
Sole Proprietor Liability
As a sole proprietor, one issue that you should be aware of is that you’re personally liable for all debts and obligations that relate to your business, including the actions of your employees and contractors. For example, suppose you operate a home renovation business and while renovating a kitchen at a client’s home, your employee causes significant damage. In this situation, you’re personally liable for cost of the damage. However, your liability remains the same even if it’s a contractor rather than an employee who causes the damage.