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Contract Workers vs. Employees: What Your Business Needs to Know

Jennifer Post
Jennifer Post

Hiring a contract worker could save a business money on salary, health benefits, paid vacation, etc., but there are limitations to hiring a contract worker over an hourly or salaried employee, and vice versa. Here is some helpful insight to understanding the difference between contract workers and employees.

Contract worker versus employee

There are many differences between a contractor and an employee, but in simple terms, the main difference is one can be controlled by the employer and one cannot.

"Most people think the only difference between an independent contractor and an employee is how they are paid. Specifically, independent contractors' pay is not subject to withholdings, such as federal income taxes and FICA taxes," said attorney Michael C. Harman. "In addition to compensation, independent contractors have more autonomy in the work they perform."

Harman noted that employees are hired to perform specific work at the direction of the employer. Independent contractors, on the other hand, are typically given a job or project to work on without being completely controlled on when and how to do it by the company, he said.

The onboarding and training process also differs greatly. Since contractors are expected to focus on a specific project, they are often given only the information critical to completing that task, according to Kimberly Schneiderman, senior practice development manager at RiseSmart. Full-time employees, she said, require lengthy onboarding processes to understand the intricacies of team dynamics, company culture and overall goals.

"Hiring goals around each type of employee is also different," Schneiderman added. "While companies work to make sure full-time employees are engaged and work to gain loyalty, these same organizations need to realize that their contractors are always looking for the next gig and are not invested in long-term outcomes, as full-time employees are expected to be."

How to distinguish an independent contractor from an employee

The IRS will look at certain factors to see if a worker is independent or should be an employee of a company. Those factors, according to attorney Christy L. Foley, include but are not limited to:

  • When, where and how the work is done. Is it done at the employer's place of business or does the independent contractor do the work at their own place? Does the employer set the hours or can the independent contractor work whenever they want? Does the employer provide the tools or does the independent contractor use their own?
  • Is the employee required to complete company training? Independent contractors usually don't.
  • Is the employee doing full-time, ongoing/continual work? Or is the independent contractor just doing temporary work on set projects that have specific end points?
  • Does the company pay the employee hourly, weekly or monthly? Or does the independent contractor just get paid once an entire project is complete?
  • Travel costs. These are usually covered by the company. Independent contractors however, pay their own travel costs (and earn enough on the overall project that those costs end up being covered by the fee they're paid).

"Technically, the IRS has about 20 factors that it looks at in determining whether someone's an employee or an independent contractor. However, the ones listed above are the most commonly used," Foley said.

Foley said that the paperwork also differs, in that contract workers don't always provide reports to the companies for which they are doing work like an employee would. The paperwork on the company's part is also different because the company doesn't have to file tax withholding documents for a contract worker.

What happens if a worker is misclassified?

The consequences for misclassification can vary depending on whether it is deemed that the misclassification was intentional.

"Typically, a company will [be] required to pay back taxes, as well as fines and penalties that can be based on the number of IRS Form W-2s that the company failed to file because of the misclassification, and a percentage of wages in which the company failed to withhold the proper taxes," said Harman.

Harman said that in extreme cases, businesses could face criminal penalties and a worker that has been misclassified could be entitled to recoup overtime pay for hours worked in excess of 40-hours per week, as well as additional monies, such as punitive or liquidated damages if the worker is successful in a lawsuit against the company.

Foley added that not only are there monetary consequences, there can also be disputes over who owns the work that was created.

"Employees' work is typically owned by the business; independent contractors' work has to be signed over to the company in a separate contract," Foley said.

Image Credit: Darren415/Shutterstock
Jennifer Post
Jennifer Post,
Business News Daily Writer
Jennifer Post graduated from Rowan University in 2012 with a bachelor's degree in journalism. Having worked in the food industry, print and online journalism, and marketing, she is now a freelance contributor for Business News Daily and business.com. When she's not working, you will find her exploring her current town of Cape May, New Jersey, or binge-watching "Pretty Little Liars" for the 700th time.