I have been outsourcing pieces of various businesses since I was a sophomore in college, but during these times I always outsourced to independent contractors and not to employees. This all changed in January of 2015 when I decided to bring on a couple of individuals part-time to help primarily with shipping & processing inventory.  Bringing them on board has been great, but there were a few additional costs that I wasn’t necessarily expecting.

Before I get into what these costs are I will first share some of the factors that go into distinguishing if an individual working for you is an employee or an independent contractor.  I will also provide this disclaimer: I am not a CPA, or lawyer, so this is not to be construed as tax/legal advice, it is simply me sharing my experiences.  One of the biggest factors in making the distinction in employee vs. contractor is that of control.  For example, if you set someone’s hours, tell them how to do the work, and pay them an hourly wage, they are likely an employee.  On the other hand, if you don’t set someone’s hours, you tell them what needs to be done, but not how to do it, and pay them based on the job/results, then they are more likely to be considered an independent contractor.  You can find a lot more information to help determine if someone is an employee or contractor from the IRS, this link is a helpful starting place.

As of January 2015 I now have employees and independent contractors working in my business.  The remainder of this post will focus on the employees.  So, let’s get to the added costs:

The Added Costs of Hiring an Employee

1. Employer Payroll Taxes & Unemployment Insurance 

The first component of these are FICA taxes.  The amounts paid are identical to the amount paid by the employee, and they are 6.2% for Social Security Tax, and 1.45% for Medicare Tax.  In total FICA taxes are paid at 7.65% on any amounts that you pay your employees.

In addition to FICA taxes you will also be required to pay unemployment insurance.  This will vary some from state to state, but in Minnesota it is currently 1.66% for my business for the state portion of unemployment insurance.  There is also a Federal Unemployment Tax Act (FUTA) that is paid on all wages.  This can be up to 6% but is more likely to be 0.6% if you are paying state unemployment taxes.   In total the state and federal components of unemployment insurance/tax cost about 2.5% of any wages that I pay to employee.

The combined effect of #1 for my business is 10.15% of the wages that I pay to employees.  Depending on where you live, you may pay a little more or less, but 10% should serve as a rough estimate.

2. Payroll Service

When you have employees, they will of course want to be paid regularly as that is part of the deal.  It is possible to do it manually and submit the various tax amounts to the different taxing authorities, and to write checks by hand to employees.  There are also options to have a service such as Quickbooks help with the calculation of payroll taxes, and to help you pay the right amount to the right places.  The last option, and the one that I went with, is to outsource the entire payroll process to an existing payroll service.  This is at a higher cost than the other options, but it requires very little time.

The payroll service that I went with charges $46.89 per month which covers paying my salary (required as I am setup as an LLC taxed as an S corporation, you can read a post I did about my business structure for selling on Amazon here). and the salaries of the 2 employees on my team.   It’s a decent cost each month, but all I have to do is login, enter the hours worked, and they handle distributing payments to me, my employees, and all of the taxing authorities mentioned in #1 above.

3. Workers’ Compensation Insurance 

The third and final cost you may not have considered is workers’ compensation insurance.  This again is going to vary from state to state, but in Minnesota it is required regardless of how many employees you have.  Some states have exemptions for less than 5 employees, or other programs to allow employers to not carry this insurance. This article is helpful for beginning to find what is required in your state.

Workers’ compensation insurance provides you coverage if any one of your employees happens to get injured while on the job and you are at fault.  The cost of these policies is based on the amount of wages that you will pay.  The amount of worker’s compensation insurance you pay will depend on the industry your business is in, currently for me the rate I pay is 5.93% of wages.   Again, this may vary, and I might shop this price around a bit in the future, but this adds nearly 6% to all wages that I pay.

In total the combination of these 3 potentially unexpected costs add 16.08% to all wages I pay, and add a $46.89 monthly fee as well.  This is a very significant amount, and can be a painful pill to swallow if you aren’t expecting it.  For example, let’s say I was to pay a wage of $10/hour to my employees, in actuality I am paying $11.68 per hour they work.   The $11.68 per hour doesn’t factor in the added payroll expense either, so in total in this example it would likely be right around $12/hour depending on the number of hours worked.

Don’t get me wrong, I am a big advocate of outsourcing, and these costs will not deter me from hiring more individuals in the future.  However, I do want to share this information, as these additional costs can add up very quickly if you are not expecting them.   The subject matter of this post may be a little dry, but I do hope it helps you in the future should you decide to add employees to your team.  If you have any questions or comments, please let me know in the comments section below!