Understanding the Differences Between Employees and Contractors | What You Need to Know

As a business owner, hiring the right people to work for you and serve your customers is a critical aspect of running a successful company. As you look to grow your team, there are two different categories of workers to be aware of: employees and contractors. Both of these types of workers serve essential roles, but it's vital to understand the differences between employees and contractors, as there are different legal compliances, tax obligations, and nuances to both. In this blog post, we’re diving into the key differences between employees vs contractors so you can make the best, most informed hiring decisions for your business.  

Key Differences Between Employees and Contractors

Definition and Role Clarity

The most fundamental difference between employees and contractors is their relationship with your business. Employees are individuals who work under your direct control and management, performing tasks assigned by you that are integral to your daily operations. On the other hand, contractors are external workers or individuals who are hired to complete specific projects or provide specialized services, working independently and autonomously from the business.

Work Schedule and Degree of Control

The degree of control that a business has over its workers is another defining aspect between employees vs contractors. Employee-employer relationships typically involve a higher degree of control and direction from the employer. As an employer, you dictate an employee's work schedule, the tasks they perform, and how they accomplish them. Contractors differ because they generally have more independence and control over how they complete their assignments, when they work, and where they work.  

Ownership of Tools

The ownership of necessary tools needed to complete a job is another distinguishing factor between an employee vs contractor. An employee will be supplied with the necessary items, tools, and softwares necessary to complete their job. A contractor must supply their own tools and softwares, as they are likely used for more than one client. 

Tax Implications

There are vastly different tax implications when hiring employees vs contractors, and understanding these is crucial. When you hire an employee, you are responsible for withholding and remitting income taxes and Social Security from their wages. Hiring contractors is different in the tax sense because they are considered self-employed and are responsible for their own taxes. As the employer, you don’t withhold taxes for contractors, but instead, they summarize their earnings on a Form 1099 at the end of the year. 

Employment Benefits

As a business owner hiring employees, you may be required to provide employee benefits, such as health insurance, retirement plans, paid time off, and other benefits, depending on your company policies and legal requirements. Since contractors are self-employed, they do not receive these benefits from your business.

Long-Term Commitment and Dependence 

Hiring an employee for your business implies there is a more long-term commitment with the expectation of ongoing work. Employees are likely dependent upon the business for their income and benefits. With contractors, these commitments may be more short-term and have a defined scope and timeline. Of course, contractor contracts can be renewed or terminated depending on the business’s needs or the contractor’s desires. Contractors likely have a roster of clients, so they are less reliant on one single client or business for their income. 

Ensuring Legal Compliance

Classifying employees vs contractors correctly is critical for legal compliance. Misclassifying employees as contractors and vice versa can lead to an array of legal issues and expensive penalties. Stay up-to-date on the specific worker criteria set out by the IRS, Department of Labor, or other state authorities in order to ensure you are differentiating the two and classifying your workers properly. 

Knowing the differences between employees and contractors is vital for managing your team effectively and ensuring compliance with tax and labor laws. As you expand your business and hire new team members, take the time to assess the nature of the work and the relationship with the individual to make the appropriate classification. Understanding these differences is key for making informed financial decisions.