Independent contractors and employees serve two very distinct purposes in the modern workforce. Independent contractors are typically entrepreneurial types who fulfill short- to medium-term assignments without commitment to a particular company, in contrast to employees who dedicate 100% of their time to an organization. Considering the fact that the number of independent contractors in the U.S. more than doubled between 2020 and 2023, it seems that the modern workforce is embracing freelance work more than ever.
But which one is right for your organization – independent contractor vs employee? How can you tell the two apart and, perhaps more importantly, how do you avoid misclassifying a worker’s status one way or the other?
What are the Differences Between Independent Contractors and Employees?
Although there are many differences between independent contractors and employees, these differences aren’t always immediately obvious. Generally speaking, and individual is classified as an employee when they:
- Are working for a business that is owned by someone else
- Receive a regular paycheck with federal taxes withheld
- Maintain an indefinite working relationship with their employer
- Depend on the employer to dictate their work schedule
- Use tools, material, and equipment provided by their employer
- Are subject to the federal minimum wage and overtime pay
Conversely, individuals are classified as independent contractors when they:
- Own and operate an independent business
- Are responsible for filing their own taxes (generally on a quarterly basis) instead of the regular tax withholding of full- or part-time employees
- Maintain a temporary relationship with their employer that lasts until the specific project is completed
- Have a greater degree of control over their own work schedule
- Has the ability to accept or decline any assigned projects
- Use their own tools, material, and equipment to complete their job responsibilities
While that covers the basics of the independent contractor vs employee debate, specific situations aren’t always so cut-and-dry.
Common Considerations When Hiring Independent Contractors
While some of the considerations discussed below may not apply to your company, it’s still a good idea to review these nuances to keep everything running smoothly.
Documentation
Apart from tax considerations, which we’ll cover later, some of the most common documents for independent contractors include:
- Project contracts: An independent contractor agreement should fully describe the relationship between your organization and the independent contractor in question, complete with any expectations, milestones, and stipulations. Ideally, a written contract should be made for each new project.
- Proof that their business is separate from yours: The most common way to prove this is by taking note of their business website, social media accounts, or any online advertisements they may have made. You might even consider printing this information in case it’s ever taken offline.
- Payment invoices: All payments to independent contractors should be based solely on their invoices. Since full- and part-time employees won’t be submitting payment invoices for their work, this is an easy way to keep them separate.
The various types of documentation mentioned above help differentiate employees from independent contractors and, if necessary, they can all be used as evidence in a court of law.
Location
You’ll want to consider the location of your independent contractors, too. While some organizations prefer to stick with local workers, the emergence of high-speed internet and the proliferation of employer of record services makes it possible for companies to consider candidates in other jurisdictions.
However, there are several considerations to make when working with independent contractors who aren’t considered local to your company, including:
- Employment costs: Not only does the cost-of-living tend to vary between locations, but so does the average salary of various jobs.
- Payments: While local workers can easily be paid in your country’s common currency, workers in other countries will need to be paid in a currency that they can actually access and use.
- Laws and regulations: There are enough considerations to make when working with contractors from different states, but these considerations only get more convoluted and confusing when working with a global workforce.
- Communications: You’ll need to be able to communicate effectively with your independent contractors, too – regardless of their location. Those who don’t speak your language, or those who operate from a different time zone, might be difficult to accommodate.
Tax Considerations
Although employers aren’t responsible for paying employment taxes for independent contractors, they are still responsible for filing the necessary tax forms every year. When working with independent contractors in the U.S., this typically involves IRS Form 1099 and IRS Form W-9. While these documents aren’t required for independent contractors outside of the U.S., individual contractors should file IRS Form W-8BEN on their own behalf.
Organizations located in countries outside of the U.S. will likely have their own tax requirements to consider, too.
Employee Benefits
Offering benefits to your full- and part-time employees is a great way to boost morale and retention – but what about your independent contractors? While many freelance workers aren’t offered the same kind of benefits, there are still a plethora of great benefits that can be useful to independent contractors. These include:
- Health insurance, including dental and vision coverage
- Employee pension or 401(k)
- Paid educational resources, including college tuition
- Company-wide discounts
- Paid travel arrangements and hotel accommodations
While these benefits cover the U.S. workforce, independent contractors in other countries might require access to certain benefits. For clarification, refer to any employment guidelines or labor laws for the country in question.
Background Verification
Companies often go to great lengths to verify the academic, career, and criminal histories of their full- and part-time employees, but they seldom follow the same processes when hiring independent contractors. However, many of the same background checks can be also performed on freelancers. Not only does this help you find the best talent available, but it can also help you identify any potential red flags before finalizing a contract.
What Happens if Your Workers are Misclassified?
According to the U.S. Department of Labor, full- or part-time workers who are misclassified as independent contractors will ultimately miss out on protections like the minimum wage and overtime pay as established in the Fair Labor Standards Act (FLSA). As such, the DoL takes worker classification very seriously. As many as 30% of U.S-based employers have misclassified one or more workers at one point or another.
Given the confusing nature of employment law, however, it can be difficult to ensure full compliance – especially when working with independent contractors in different states or countries. While there are still potential penalties for mistaken or unintentional misclassifications, cases that are deemed intentional are punished even more severely.
Tax Fines
Penalties relating to tax responsibilities for any and all misclassified employees, who would have been considered taxpayers at the time include:
- A certain percentage of the misclassified worker’s wages, up to 3%
- 100% of the FICA taxes that weren’t previously paid on behalf of the misclassified worker
- 40% of FICA taxes that weren’t withheld from the misclassified worker’s wages
- $50 flat fee for every W-2 form that wasn’t filed on behalf of misclassified workers
Wage Laws
Not only are business owners held responsible for their employee tax obligations, but, in some cases, they may be found liable for failure to pay the appropriate minimum wage and overtime fees as established in the FLSA. Workers are given a two-year statute of limitations regarding unintentional misclassifications or three years for intentional acts.
Federal Penalties
Organizations that misclassify employees may face penalties under federal law, too. Many of these depend on the severity of the act, including whether or not the misclassification was intentional. Potential federal penalties include:
- Fines up to $1,000 for each misclassified worker
- Class-action lawsuits from misclassified workers
- Repayment of benefits insurance or unemployment insurance on behalf of misclassified workers
- Wage claim audits spanning the past three years
- Failure to provide misclassified workers with job-protected leave
- Anti-discrimination lawsuits from misclassified workers
- Up to one year in jail
As you can see, claims of employee misclassification in regards to independent contractor vs employee are taken very seriously by the IRS, the DoL, and other regulatory agencies.
Bottom Line
Whether you’re in charge of a large or small business, both independent contractors and employees can be used as integral parts of the same team. While freelancers tend to perform better on short-term projects and even some extended engagements, most employers seek out full-time employees to fulfill their long-term needs.
