How to Decide Between an Employee and a Contractor

Calculate the true costs and legal requirements to decide whether to hire employees or contractors for your business.

1. Calculate the true employment cost multiplier. Add payroll taxes (7.65% employer share), unemployment insurance (0.6-6% depending on state), workers' comp (0.75-2.5% average), and benefits if offered. Most employers pay 125-140% of base salary when fully loaded. A $50,000 salary costs $62,500-$70,000 total.
2. Price the contractor alternative. Contractors typically charge 25-75% more per hour than equivalent employee wages to cover their taxes, benefits, and business overhead. A $25/hour employee role might cost $35-45/hour as a contractor. Factor in reduced management time and no benefits administration.
3. Apply the IRS control test honestly. Employees work when, where, and how you specify using your tools and training. Contractors control their methods, use their tools, work for multiple clients, and deliver specific results. Misclassifying costs 1.5x the unpaid taxes plus penalties — often $3,000-$15,000 per worker per year.
4. Set your breakeven hours threshold. Calculate annual hours where employee total cost equals contractor cost. If you need someone 20+ hours per week year-round, employees usually cost less. Under 15 hours weekly or project-based work, contractors typically win on pure economics.
5. Factor in operational complexity. Employees require payroll systems, HR compliance, management overhead, and termination procedures. Contractors need clear SOWs, 1099 tracking, and project management. Add $2,000-$5,000 annually per employee for compliance and administrative burden.
6. Document your classification decision. Write down your reasoning using IRS factors: behavioral control, financial control, and relationship type. Keep records of how work is assigned, paid, and supervised. This documentation protects you if classifications are questioned during audits.