Independent Contractor vs Employee: What’s the Difference?

How you classify your workers matters — fact. Companies that are mis-classifying contractors have been facing steep fines.  If you’re wondering what the differences are between an independent contractor and an employee, you’re in the right place. Let’s look at a quick definition of both types of worker, and how that makes a difference in practice.

Employees definition

The IRS says that an employee is anyone who works for you where you define “what will be done, and how it will be done.” For example, you could tell an employee where they need to work from, or how much you’re going to pay them for that work.

An employee is a predictable cost for a business, as they are usually paid a fixed salary, but they are also a comparatively expensive outlay, as their costs will include benefits such as Paid Time Off, taxes, and extras such as expenses or training. There is a lot more operational complexity involved in hiring an employee over a contractor. For example, you’ll need to pay Social Security taxes, Medicare and Unemployment, as well as Health insurance, 401k matching, Disability insurance and Worker’s compensation.

Independent Contractors definition

In contrast, according to the IRS, an Independent Contractor gets much more control over how they work, and all that you as the employer get to define is “the result” of the work. Elements such as the pay, the location, or the hours of the worker are under their own terms. This is a perfect arrangement for employers who want to gain a niche skill quickly, or augment an in-house team with some specialist expertise or more manpower for a specific project.

The costs are generally lower, but far less predictable, as the contractor may be charging by the hour, and you have less control over the end price. A freelancer or an independent contractor is responsible for filing their own taxes, and all you need to do operationally is fill out Form W-9.

Distinguishing Between Contractor and Employee

In some cases, it’s obvious which is a contractor vs a full-time employee. For example, a full-time salaried lawyer who completes their work from your law-firm’s offices, and only works with your company’s clients. This is clearly a full-time employee. At the same time, an ad-hoc graphic designer who you take on for occasional limited design work when they’re available, and according to their own pre-defined rates is very distinctly a freelancer or an independent contractor.

However, in other cases, the differences will be more difficult to distinguish. Let’s say for example that you have a member of staff who lives and works abroad. They work in their own time zone, and you pay them in their local currency, but they provide 40 hours per week of work for your company, and you set the rates and the scope of what they do. Is he considered an independent contractor, an employee, or maybe a combination of both being statutory employee?

Not so simple, right? How about a local worker who you onboard as a freelancer, but agrees to a set amount of work on retainer each month, and asks you to provide their expensive working equipment or looks to you for professional development opportunities? Neither of these cases are black and white. Furthermore, when distinguishing freelancers vs contractors, the first usually has many clients, whereas the latter usually works on long-term projects with fewer clients.

Today’s global working reality has made this even more complicated. For a worker to be an employee of a US-based company, they need to be eligible to work in the US. Many companies mistakenly believe they can get around this by onboarding overseas workers as contractors. However, in reality they either need to open a legal entity in the region in which the candidate is working, or utilize an Employer of Record relationship. 

Helpful Resources for Employee vs Independent Contractor

Internal Revenue Service, “Understanding the Employee vs Contractor Designation”
MIT, “Estimating the Cost of an Employee”
Nolo: “Documentation Required to Work in the United States”
US Dept of Labor: “Fact Sheet: What is an Employee Relationship under the Fair Labor Standards Act (FLSA)?”
JD Supra: “A Decade of Examples of Contractor Misclassification”
If you’re still not sure which designation your worker needs, you can ask the IRS to make the decision for you, by filling out this form. 

The Papaya Advantage

Papaya Global utilizes a specialized center of excellence model, with vast expertise and support on different types of employment, and how each will impact your business growth. Uniquely, we also offer a full range of global workforce solutions, including technology that manages everything from payroll employees and contractors, to Employer of Record relationships worldwide, so that you can get a single view of your whole workforce, no matter who that includes.

For more information, reach out here.