Contractors vs. Employees: What’s the Difference?

When you need a job done, you hire somebody, right? But when you’re the decision-maker for a business, it’s not that cut and dry. At the core of the decision is whether you should hire an employee or a contractor. Both can bring valuable skills to the table, but they fall into two very different legal and financial categories.

Essentially, an employee is part of your company, and is typically offered a benefits package and salary. A contractor is an independent worker hired for a specific task or project, with a higher degree of autonomy. Let’s take a deep dive into the differences between contractors and employees to help you know when to hire each.

What Is an Employee?

An employee is a worker who is part of a company’s team, with the business holding control over what work they do and how they do it. The relationship usually has a consistent schedule and a steady wage or salary. The employer provides all the necessary tools and equipment, and the employee receives training and direct supervision. Employees are often expected to work exclusively for one company.

For example, a graphic designer hired for an in-house team at a software company is an employee.

What Is an Independent Contractor?

An independent contractor is a self-employed individual or a business hired for a specific service under a contract. Unlike an employee, a contractor sets their own hours and work schedule, uses their own tools, and works with minimal supervision from the hiring business. Contractors often work on multiple projects with different clients, getting paid by each via a flat fee or a per-project basis rather than a regular wage.

If that same software company brought in a graphic designer for a specific project, they’d likely hire a contractor.

Key Considerations About Contractors vs. Employees

There are a few important legal and financial considerations that both employers and workers need to know when it comes to comparing contractors and employees.

For the Employer/Business

As an employer, when you hire an employee, you are responsible for withholding and paying income tax, Social Security, and Medicare taxes (known as FICA), as well as federal and state unemployment taxes. In some states and situations, you must also provide benefits like health insurance, paid time off, and sick leave, and comply with minimum wage and overtime laws. You’re also generally responsible for an employee’s actions while they are on the job and may have to pay them workers’ compensation if they’re hurt in the line of duty.

With a contractor, these burdens are significantly reduced. You don’t withhold or pay any of these taxes, and you are not required to provide benefits — they have to figure those things out on their own. Plus, the contractor typically assumes their own liability for their on-the-job actions.

For the Worker

There are also significant differences from the worker’s perspective. Employees have a simpler tax process since they can be automatically deducted from their paycheck. They also typically have more job security, more steady income, and employer-provided benefits. The trade-off is that they must adhere to the company’s rules, schedules, and management, thereby giving up some personal autonomy.

Contractors have a great amount of freedom and control over their work. They can choose their clients, set their own hours, and provide their own direction in completing projects. It’s a lot more flexible, but at a cost. Contractors have to manage their own quarterly tax payments, cover their own business expenses, and manage their own healthcare and retirement costs. Plus, unless they have an extremely steady client base (rare), they often have to continually search for new work.

How to Determine the Correct Classification

The IRS is very serious about the classification of workers. Misclassifying a worker can lead to severe penalties for a business. To avoid making a mistake, use the IRS common law test:

1. Behavioral Control: Who controls what the worker does and how they do it? If the business dictates training, tools, and methods, the worker is likely an employee.
2. Financial Control: Who controls the financial aspects of the worker’s job? If the business reimburses expenses and pays a consistent wage, it points towards an employee relationship.
3. Type of Relationship: Is there a written contract? Are benefits provided? Is the relationship permanent? These factors help determine if the worker is an integral part of the business or an independent entity.

The IRS advises businesses to consider all three factors when classifying workers. No single factor can definitively classify a worker, and the totality of the circumstances is what truly matters.

When to Choose a Contractor vs. an Employee

The right choice depends on your specific business needs, which may change over time.

Choose a contractor when:

• You need specialized skills for a short-term or a one-off project.
• Your needs are project-based or seasonal, and you don’t require a permanent position.
• You want to avoid the long-term commitment and costs associated with hiring an employee.

Choose an employee when:

• You need someone for a permanent, ongoing role that is essential to the core operations of the business.
• You need to maintain a high degree of control over the work and the schedule.