BusinessNews and Notes

Employees vs. Contractors: What You Need to Know

By April 8, 2022No Comments

When hiring new workers to join your team, you have two options: employees or contractors. It’s important to know the differences, benefits, and drawbacks of employees vs. contractors in order to hire the right fit to meet your business’ needs. 

Employees vs. Contractors: The Basics

Here are the basic definitions of an employee vs. a contractor, which will be discussed in more detail throughout this article. 

  • An employee is on a company’s payroll and the company is responsible for withholding taxes, Social Security, and Medicare from the wages paid to the employee. 
  • A contractor is self-employed and hired by a company on a contract basis. The company is not responsible for withholding any taxes from the contractor’s payment. 
  • If a company misclassifies a worker, it can result in paying fines, penalties, and back taxes. 

At face value, hiring a contractor rather than a full-time employee seems to hold numerous benefits for a business. After all, you are saving money because you don’t have to pay their health insurance, vacation time, or other benefits. However, it’s important to look closely at this option because hiring contractors can come with potential drawbacks and limitations. Before you decide whether to go the employee or contractor route, it’s important to understand the key differences, benefits, and drawbacks of each. 

What is a contractor? 

A contractor can also be known as an independent contractor, contract worker, or freelancer. They are self-employed and run their own business, such as a sole proprietorship or LLC. Contractors work for a company solely on a contract basis, which can be long-term or short-term. Typically, contractors are hired by a company to work on a specific project or assignment. Because contractors are self-employed, they can take on projects from multiple businesses at the same time and are not tied to one specific company. 

What is an employee? 

An employee is what most often comes to mind when a business is hiring a new worker. Employees are hired by a company to do a specified job and typically desire to work for a company long-term. 

Employees vs. Contractors: The Determining Factor

To put it briefly, the determining factor of an employee vs contractor is the degree of control the company has in regards to the worker. 

According to the IRS, there are 3 categories that must be considered when determining whether a worker is an employee or contractor: 

  • Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
  • Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
  • Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

(Source: https://www.irs.gov/businesses/small-businesses-self-employed/independent-contractor-self-employed-or-employee)

While there is no set number of factors that automatically determine whether a worker is an employee or a contractor, the key is to look at the relationship in its entirety and consider the right of the company to direct or control the worker. It is important to document the factors used in determining your decision. 

Employees vs. Contractors: Other Considerations

The differences between employees and contractors go beyond whether or not they are on a company’s payroll. Here, we’ll get into more detail on the key differences between employees and contractors so you can make an informed decision on which one will best benefit your business. 

Payment, Taxes, and Benefits

One primary difference between employees and contractors comes down to payment, taxes, and benefits. This is one of the first things that comes to many business owners’ minds when considering hiring an employee or contractor. As previously mentioned, employees are on a company’s payroll while contractors are not. When a company pays their employees’ wages or salary, they are responsible for withholding the appropriate taxes, such as income tax, Social Security, and Medicare. The company is also responsible for paying their portion of the employment taxes for each employee.

In addition to paying an employee’s wages or salary, companies also often pay for the benefits of their full-time employees. These can be required benefits, like health insurance, while others are desirable benefits such as retirement, paid vacation, stock options, etc. 

However, with a contractor, the company simply pays the contractor an agreed upon amount as stated in the contract. The company is not responsible for withholding any taxes or providing any benefits, like health insurance or paid time off, to contractors. Contractors are responsible for paying their own taxes, including federal income tax and self-employment tax. 

Hiring Goals and Practices

Typically, employees are hired for the long-term while contractors are hired on a short-term basis. (Although this is not always the case, this can be expected.) Oftentimes, a company will put more effort into focusing on the loyalty of an employee than a contractor. There is generally an expectation of long-term loyalty from an employee that is not there for contractors. Contractors are often hired for a specified time period to complete a specific project. 

When hiring an employee, the same basic hiring practices can be expected from any company. A potential employee puts in an application which gets sent to human resources. Then once the applicant is approved, they receive a job offer that they can choose to accept. Once the job offer is accepted, human resources will ask for additional information about the employee such as date of birth, marital status, and citizenship status. 

However, when hiring a contractor, many companies seek out contractors based on their area of expertise, hiring them to complete a specific project or assignment. The contractor normally interacts with the person or department that needs a service or task completed. The contractor will send a proposal, and once accepted by the company, will enter into a contract agreement that specifies the scope of work to be completed. 

Autonomy and Flexibility

Another key difference between an employee and a contractor is the level of autonomy and flexibility each have. Typically, contractors have higher autonomy and flexibility in their work. A company hires an employee to complete specific work at the direction of the employer. Because an employee works for a single company, they are subject to the rules and obligations set forth by that company. For example, an employee is only allowed to take the number of vacation days set by their employer, though they are often compensated for those days. 

On the other hand, contractors are hired to do a specific project or task without the company controlling when or how they do it. Because contractors are self-employed, they have the option to work for multiple companies at the same time, depending on how much work they want to take on. Contractors can also take vacation time whenever they want; however, they are not paid for that time off.

Intellectual Property 

When hiring someone to create something for you, you will want to own the intellectual property rights to the creations. With an employee, the company generally will own the rights to any intellectual property created within their scope of employment, during company time, and on company equipment. 

However, with contractors, things get more complicated. Generally speaking, a contractor will own the rights to any intellectual property created, even if you are paying them to do it. You must use explicit assignment of intellectual property rights in the written agreement with the contractor. 

We’re here to help!

If your business is in the process of bringing on more workers to the team, be sure to determine whether an employee or a contractor is the best fit for your needs. Ask yourself what your goals for hiring the worker are and look back through the key differences listed above. 

If you are unsure which would be the best option for your business, reach out to us. We offer Client Advisory Services to help walk you through your options and determine the long-term effects of each on your business.