Should I Hire an Employee or a Contractor?
At some point in any business lifecycle, it is likely the owners will need to ask themselves “Should I hire an employee or a contractor?”
You must understand the difference because the cost of getting it wrong is high.
Even a micro business will probably never be highly efficient with an owner trying to do everything. If you want to grow your business, you will need help, probably starting with jobs that you hate but must be done.
In this article:
If you’re unsure about anything in this article and have more questions, feel free to get in touch.
What is the Difference Between an Employee and a Contractor?
You can’t just hire someone and decide they are either an employee or a contractor. Regardless of what you call them, their true status depends on the working arrangement.
While the arrangement may have elements of employment and elements of contracting, by reviewing a series of criteria, it should become clear which one wins.
The overarching principle is control.
How to determine whether someone is an employee or a contractor:
An employer tells an employee how, when and where to work. An employee will often work on the employer’s premises, at set times, performing their job as prescribed by the employer.
A contactor chooses how, when and where they work. A contractor can often work at their own premises, on their own schedule, in their own way.
An employer provides equipment and reimburses employees’ job-related expenses.
A contractor provides their own tools and covers their own costs.
An employer pays a fixed rate or salary.
A contractor charges on their terms, either by the job, hour, performance or other arrangement.
An employee is usually restricted to working for one employer.
A contractor is free to work for many customers.
What are the Employment Requirements of Hiring an Employee?
Employing staff implies legal obligations under the Employment Relations Act, Holidays Act and a few other laws.
- Employment Agreement – You need a compliant, written employment agreement for each employee. The agreement must contact certain mandatory clauses and can contain other optional clauses. You can build an agreement using the NZ government’s Employment Services tool:
- Employer Registration with IRD — This can be done at https://www.ird.govt.nz/ or ask your accountant to help.
- Pay Employees for Time Worked – Including time and half if they’re required to work on a public holiday.
- Pay Employees for Leave – Entitlements include a minimum four weeks annual leave, ten days sick, three days bereavement leave and statutory holidays.
- Calculate and Deduct Pay As You Earn (PAYE) from Wages – Including the employees’ income tax calculated per their tax code, Kiwisaver deductions if applicable, and ACC earner levies.
- File PAYE Returns – Must file an Employer Information Form to IRD within two business days of each payday.
- Pay PAYE to IRD – Including PAYE deductions as above and employer Kiwisaver Contributions. For small businesses, PAYE is due by the 20th of the month following the pay date.
- Pay ACC Employer Levies –ACC will invoice the employer based on wages information passed onto them by IRD
- Comply with Employment Related Legislation – Including minimum wage requirements and following correct procedures when terminating employment.
What are the Requirements of Hiring a Contractor?
If you hire a contractor, you will have an Agreement for Services instead of an Employment Agreement. This is much more flexible.
Generally, a contractor will have no leave entitlements, pay their own tax – although sometimes the contracting business will deduct withholding tax – and pay their own ACC levies.
Benefits of Hiring an Employee vs Contractor
Both scenarios have their own benefits and challenges so you will need to weigh up which are most important to you and your business.
Hiring a contractor can work really well for businesses who need specialist skills for a particular project and/or period of time. Maybe they need someone at short notice – Finding the right employee takes time. By hiring a contractor, the business is not required to commit a salary and associated benefits for the long term.
Hiring an employee works well for businesses who want to build up a competent workforce to provide ongoing services to customers. Holiday pay and other leave entitlements are also attractive to employees who want job security and to be integrated into a team.
The main reason for choosing a contractor over an employee is the flexibility the arrangement offers.
Get it Right – It’s Important!
If your “contractor” turns out to be an employee, you may be liable for tax you should have deducted plus penalties, ACC levies, payments for leave, and potentially other breaches of employment law.
Robb MacKinlay is an accountant and business advisor to professionals and consultants, helping them convert their expertise into profitable business.
Contact us with your business questions.
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