Independent contractors vs. employees: Exploring the differences

Without proper guidance, the hiring process can be complex and fraught with legal pitfalls. One of the most crucial decisions is choosing between hiring independent contractors or traditional employees. Understanding the differences between these types of workers is essential to ensure compliance.

Here’s what you need to know to make this critical hiring decision. 

What’s the difference between independent contractors and employees?

In the United States, the Internal Revenue Service (IRS) differentiates contractors (also known as 1099 workers or contract employees) from traditional employees with a right-to-control test. This determines who controls the work performed—the client or the worker—and considers financial and behavioral factors and the relationship between the two. 

Financial control factors may include:

• Does the client provide tools such as laptops and other equipment? 
• Does the client take on financial risks and bear responsibilities for loss or profit?
• Does the client deduct taxes from the worker’s paycheck?
• How frequently is the worker paid?
• Does the client set the rate of pay for services?
• Does the client reimburse expenses?

Behavioral control factors may include:

• How closely does the client direct the worker’s actions? 
• Does the client provide the worker with any training?
• Who gives the worker assignments?
• How frequently does the worker perform services?
• Is the worker required to attend meetings?

Relationship factors may include:

• Does the contract have an end date, or might the collaboration continue indefinitely?
• Does the worker have other clients? 
• Where is the work performed?
• Can the worker accept work outside the client?
• Does the client treat the worker like an employee? Are they invited to staff announcements and employee events? Do they receive performance reviews like employees?

You should also consider economic and financial risks when determining whether to hire contractors or employees. Many of the key differences relate to financial and legal standards.

Employment laws

U.S. employees are protected by various federal and state employment laws, including minimum wage, whistleblower protections, discrimination protection, health coverage requirements, privacy policies, and workplace safety laws. Though protections vary by state, contractors generally don’t get coverage as comprehensive as employees. For example, they aren’t protected by federal minimum wage laws or entitled to overtime pay.

Wages

Another factor separating employees from independent contractors is the distribution of wages. Employees are paid based on time worked, either hourly or in salary. Self-employed contractors are paid based on a contract that can reflect the time spent or the results of work.

Taxes

Employers withhold deductions like unemployment taxes from employees’ paychecks and make matching contributions when mandated. Contractors must budget their own income to ensure they have enough to cover self-employment taxes. Businesses fill out different IRS forms for each type of worker.

Paydays

Employee paydays are subject to state laws, which might mandate weekly, biweekly, semimonthly, or monthly pay dates. Not all states dictate pay frequency; each has unique exceptions and restrictions. Contractors may be paid upfront, at the end of a job, or based on work-related milestones.

Why is it important to understand the difference? 

It’s possible to transition someone from being an independent contractor to an employee, but it’s easier to classify them correctly from the get-go. Drawing this distinction benefits the potential employee and helps keep your organization compliant.

Misclassifying an employee is a common mistake, but it has serious repercussions. Some of the consequences of misclassification include:

• You could be the subject of a class-action lawsuit due to wage law violations or unlawfully denying employee benefits.
• Would-be workers may have grounds to sue for failure to follow anti-discrimination laws.
• You could face penalties for failing to file employment forms or pay taxes.

Businesses that violate employment classification laws could be liable for:

• Back wages
• FMLA violations
• Employment taxes
• Retirement contributions
• Medicare and Social Security contributions
• Health insurance
• Unemployment insurance claims
• Workers’ compensation claims
• Benefits claims

In extreme cases, the employer could face prison for deliberately misclassifying workers as independent contractors.

Remember, the IRS decides who’s an employee and who’s an independent contractor. They examine the work performed (not just a worker’s contract) to the provisions of the Fair Labor Standards Act (FLSA).

Pros and cons of hiring contractors

Independent contractors provide unique benefits and drawbacks for a business. Employers should consider these factors when making hiring decisions:

Pros

• Staffing flexibility: If a project requires specific skills but you don’t need a full-time employee in that domain for other projects, an independent contractor can be the perfect solution. Contractors work as required and move on once the project is complete.
• Financial savings: You only pay contractors for the work they provide, whereas employees receive an annual salary or hourly rate. Employers aren’t required to provide contractors benefits, such as paid time off, health and disability insurance, or retirement planning options. You also won’t have to worry about independent workers’ income tax, Social Security, or Medicare taxes unless they factor these expenses into their rate.
• Skilled work without extra training: Contractors possess specific talents. These skilled workers generally require very little training on the projects for which they’re hired. You may need to provide some background information about the project’s scope and the company’s overall strategy, but independent contractors typically deliver quality work sooner than untrained full-time employees.

Cons

• Less control over how work is done: Contractors have more freedom than employees, giving you limited control over their workflow. Therefore, maintaining clear communication about expectations and deadlines is a must.
• Less reliability: Since contractors are not obligated to maintain a specific work schedule or work exclusively with you, they may not be available to complete work within your timeframe. Projects may become delayed or drawn out.
• No long-term commitment: As the name suggests, contractors typically sign an independent contractor agreement with employers. The terms may require that they provide services for a set duration or until a project is completed. Contractors usually move on after their requirements have been fulfilled. This means you could lose out on great talent—unless you convert your best contractors to full- or part-time employees.

Pros and cons of hiring employees

Employees require a greater investment of time and money from their employers than a contractor does from a client. However, that investment can pay off in the long run. Here are the essential considerations:

Pros

1. Reliability: Employees maintain a set schedule, so you can trust them to work consistently. You can also assign them various projects or responsibilities that fall within their job description.
2. Company loyalty: Employees generally expect to maintain a long-term relationship with their employers. This minimizes turnover, which would otherwise use up resources, such as time and money spent on recruiting and training.
3. More control over work: Management has greater oversight over employees, giving you more control over how work is completed. Projects can more easily satisfy precise expectations.

Cons

1. Increased liability: You’re responsible for your employees’ performance, as well as any injuries that occur while they’re at work. This increased liability comes with added financial risk.
2. Increased financial obligations: As an employer, you are responsible for withholding or paying for employees’ income taxes, Social Security, Medicare, and workers’ compensation insurance. To attract the best talent, you must also offer a compensation package with other incentives, such as health insurance and paid time off.
3. More training: Employees generally require more onboarding than contractors. You’ll need to familiarize them with the company’s mission, strategy, policies, and expectations for their role. Because employees typically have more responsibilities than contractors, onboarding them requires more time (and money).

Find great talent anywhere

Having access to a global talent pool makes hiring easier, but even then, finding the right people for your team can be challenging. If you have a contractor who is an ideal fit and are considering bringing them on as an employee, Oyster can assist you in making this transition seamless. The comprehensive platform can also help you hire the best contractors for your niche or project-based talent needs. 

Discover how Oyster can revolutionize the way your business attracts, hires, and retains top talent worldwide.

About Oyster‍

Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.

Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.