An increasing number of businesses are opting to hire freelancers rather than employees. Could following suit benefit your business? While there are tax benefits to hiring freelancers, also known as independent contractors, there are also risks that business owners need to be aware of. This guide will help you decide if freelancers are right for your business.
Why Hire Freelancers?
There are big tax benefits to hiring freelancers, which we'll discuss below. However, tax savings aren't the only reason businesses prefer hiring freelancers. As many regions face labor shortages, freelancers offer businesses a way to access talent outside the local employment pool. Freelancers are a popular choice for high-tech and creative roles like web development or graphic design, but businesses are also turning to freelance help for administrative support, bookkeeping, and other jobs traditionally done in-house. Despite the learning curve required to coordinate with remote workers, many businesses find that, with freelance workers, they can achieve much better outcomes at lower costs.
Hiring freelancers is also easier in many ways. When hiring a permanent employee, managers have to be cautious about who they pick. You don't just need someone who can do the job; you need an employee who's invested in your company's culture and bottom line. Finding the right person requires phone calls, interviews, and follow-ups, a process that takes time and money. Freelancers, on the other hand, are intended to be temporary. You don't need someone who will show up to company picnics or pursue professional development; you just need someone who has the skills to do the job at hand. From searching freelance job boards such as Upwork to signing a contract, hiring a freelancer takes a matter of days, not weeks or months.
Tax Benefits of Hiring Independent Contractors
Tax savings are among the top reasons businesses opt to hire independent contractors. When hiring freelancers, businesses are no longer responsible for:
- The 7.65 percent employer FICA tax contribution. Since independent contractors pay their own Medicare and Social Security taxes via the self-employment tax, employers don't have to make contributions on their behalf.
- Unemployment taxes and workers' compensation. Neither independent contractors nor the companies that hire them are required to pay state or federal unemployment taxes or workers' compensation insurance.
- Benefits. Employers aren't required to provide benefits, including health insurance and paid time off, to independent contracts regardless of the number of hours worked.
- IRS Forms W-2 and 1040. While employers do need to collect W-9 forms from independent contractors, submit Form 1096 to the IRS, and send a Form 1099-MISC to contractors they pay $600 or more, these tax forms are simpler to complete.
- Remitting payroll taxes. Independent contractor taxes aren't taken out of the check. Instead, employers simply remit payment and let their freelancers handle taxes. As a result, payroll processing is greatly simplified.
A Word of Caution
According to the IRS, anyone who is self-employed is an independent contractor, whether they call themselves a freelancer, consultant, or sole-proprietor. However, calling someone an independent contractor isn't enough. Workers also have to meet certain criteria in order to qualify as an independent contractor for tax purposes. While some businesses classify would-be employees as independent contractors to save on taxes, doing so is a bad business move. If a company is caught misclassifying employees, it's subject to back taxes as well as fines and penalties from the IRS and Department of Labor, including up to one year in prison.
As you can see, there are big tax savings to be had when you hire freelancers. However, the savings only apply if you do it right. Misclassifying employees as independent contractors will cost your business far more than it saves, so before adding freelancers to your business, make sure you understand IRS and DOL guidelines regarding independent contractors.