Small businesses turn to independent contractors

New York —- As the recession forces small businesses across the country to cut expenses, some are making a dramatic shift —- they’re laying off employees and using independent contractors instead.

Back in 2006, Ron Gold had only full-time employees in his advertising agency, but business began to slip and he began using freelancers. Last year, he closed the agency and started a marketing services firm, using only independent contractors —- some of whom used to be former staffers.

“It was not that we wanted to hurt anybody, but we needed to grow,” said Gold, owner of Marketing Works in East Setauket, N.Y. He noted that with employees, he had to keep paying them even when business was falling off and there wasn’t as much work to do.

Bonnie Harris also began using independent contractors when her marketing business slowed in 2007. Until that point, she had four full-time employees as well as part-timers.

“My business was really having a hard time, and the biggest problem was payroll taxes and employees, carrying salary burdens,” said Harris, owner of Wax Marketing in St. Paul, Minn. “I couldn’t pay myself because I was paying these people.”

So she began replacing her employees with independent contractors. The result: “2008 was our best year.”

There are many benefits to hiring contractors rather than employees, and not just during a recession. Businesses don’t have to pay for benefits and don’t owe the government payroll taxes for contractors. When there’s less work to be done, the contractor isn’t paid, unlike the employee who draws a regular salary.

“It makes my business more profitable, without a doubt,” said Charles Barrett, owner of FZ Media Design, a graphic arts and Web design company in Yardley, Pa.

Besides saving on benefits, he noted that he doesn’t need as much office space, and that reduces his expenses.

Barrett made the decision to use only contractors when he started his business five years ago, and he credits that strategy for helping his company to flourish even in a sluggish economy.

Moreover, he said, “by not carrying all the overhead, I’ll be willing to pay a higher hourly rate” to draw talented workers.

There are other pluses: Owners can hire different contractors for different projects, depending on workers’ strengths and talents.

It also means less time spent managing workers. Harris had an unexpected feeling of relief without any employees.

“What I didn’t have was the burden of feeling responsible for that person’s career, helping them grow and learn,” she said.

Harris also found she was more free to make her own hours when she no longer had staffers to supervise.

But making the switch from full-time employees to contractors also meant a learning curve —- supervising an independent contractor is very different from overseeing the work of someone on your payroll.

“It was hard for me to figure out how to do it at first,” she said. “You tell them, ‘here’s this task,’ and you have to be specific, and you’re not there in the office with them.”

The difficulty that Harris encountered comes in part from the fact that independent contractors must by law be treated differently from employees. An owner doesn’t have what the Internal Revenue Service calls the right of control over contractors —- for example, the place where they work, the hours they put in on a project, the tools they use and how much supervision there is.

If a worker is too much under the control of an owner, the IRS could find that this is in fact an employer-employee relationship, and the business then must pay Social Security and Medicare taxes retroactively and will also have to pay penalties.

Owners can find information at www.irs.gov/businesses/small/article/0,,id=99921,00.html to help them determine whether the way they’re treating workers makes them employees or contractors.