Employees vs Contractors: What's the difference and why your business should care

We're changing the way we work. More companies are going remote, more workers are working multiple jobs, and there's also been an uptick in independent contractors.  

According to Statista, the number of independent contractors increased from 12.9 million to 23.9 million. And that's just occasional contractors — there are plenty of contractors who work full time.

So, what's the difference between the two and, more importantly, what do those differences mean for your business? Here's what you need to know.

What’s the difference between an employee and an independent contractor?

There are distinct differences between an employee and an independent contractor — and those differences aren't just about who pays for their insurance. The differences can impact what tasks you can ask your team to do, where they work, and your daily interactions.

An employee is defined as a person who works under the supervision and control of an employer.

If you hire an employee, they are under your supervision. You can tell them when to show up for work, when to go home, what clients to work with, who they report to, and so forth.  

Of course, you can't ask them to do anything illegal or break laws. But you can require them to show up for a 5 a.m. meeting, for example. (Why you'd do that is an entirely different story, the point is you can require it as a condition of employment.)  

An independent contractor is defined as a self-employed person providing services or goods to another party with the right to control how and when the work occurs.

An independent contract doesn't work for you. They might do work for you, but you're not the boss of them. 😉 Rather, they are self-employed people responsible for setting their own rates, paying their own taxes, and they can definitely say no to that 5 a.m. meeting.  

The legal definition of a contractor varies by state. In general, however, you can't tell a contractor when or how they complete their work. You can say "Hey, I need five blog posts on these topics, can you get them to me by next Tuesday?" but you can't say, "I need five blog posts, written using this specific tool, due next Thursday, and you need to sit in our office between 9 and 5 to finish them."

Is it better to hire an independent contractor or employee?

The truth is, it depends. I know, a very unsatisfying answer. No two businesses are the same, and no two business needs are the same. In fact, your company might need to leverage both employees and contractors at different times.  

To get a better understanding of when it might be better to hire a contractor over an employee (or vice versa), let's look at the pros and cons of each.  

Independent contractor pros

There are plenty of benefits to hiring an independent contractor for your business. Need an SEO audit? You can hire an expert contractor with tons of experience and get just what you need.

There are other benefits as well, including:  

• Easier to scale — you can start and end contracts as needed.  
• No need to manage benefits, calculate withholdings, or pay employee taxes.  
• Hire for the skills you need when you need them.  

Contractors also reap benefits in many cases. They can charge higher rates, pick and choose the contracts they accept, and often work remotely.

Independent contractor cons

There are a few drawbacks to keep in mind. Depending on your needs, these cons may make hiring an employee a better fit.

Cons for companies hiring contractors include:  

• Less control over the work. You can't set limitations on how or where the work is done.  
• Higher costs. Contractors generally charge higher rates because they cover their own taxes and often have higher levels of expertise.  
• Lack of loyalty/feeling like a part of the team, which can impact communication and overall work experience.

Cons from a contractor's perspective include paying a higher tax rate, lack of PTO, and less job security.

Employee pros

Are employees a better choice? Not always. However, there are several benefits to hiring employees for your business, including:

• Build long-term relationships, which can improve communication and training.
• Easier to plan projects, since you have more control over when and how the work is completed.
• Lower hourly wage, though you do pay a portion of their taxes and benefits, which increases costs above the base rate or salary.

Employees also reap benefits from being an employee, including paying less taxes, gaining benefits like health insurance and PTO, and the stability of a regular paycheck.

Employee cons

As you consider whether an employee is the right fit, you'll want to consider the con to hiring an employee as well. Here are a few things to keep in mind:

• Offering benefits, like insurance and 401K, can be just as costly as hiring a contractor.  
• Employees must be paid whether or not there's work. If a project goes south or your own clients leave, you still have to pay employees (or lay them off.) This makes it harder to scale.  
• Hiring employees requires infrastructure, such as setting up payroll tax withholding, managing PTO, etc. The costs of software and the time investment shouldn't be underestimated.  

Employees have less control over their hours and pay, and are at the mercy of the employer for insurance and other benefits. In at-will states, they may have very little job security.

What is the difference in taxes of an employee vs. an independent contractor?

Contractors pay their own income tax and also pay Social Security and Medicare taxes (called self-employment taxes.) The business incurs no costs outside of the contract rate and must submit a 1099 at the end of the year to the contractor, detailing the amount paid.

Employees don't have to pay self-employment tax. Their employer pays for half of their Social Security and Medicare taxes, and the rest automatically comes out of their paychecks. This makes tax season a lot less stressful — and cheaper.

For companies, what is the risk for classification as an independent contractor vs. employee?

This is actually one of the greatest risks to hiring an independent contractor. If you get it wrong, your business could be sued. Businesses like Google, Uber, and Lyft have been hit with independent contractor misclassification lawsuits in recent years. Depending on the size of your business and the number of misclassified employees, the cost can be astronomical.

Employees vs Contractor Conclusion

So, which is right for your business? As you can see, it depends. It makes more sense to hire an employee who becomes a reliable part of your team in some situations. In other cases, such as for shorter projects or quick-scaling businesses, hiring a contractor makes more sense.

Whether you hire employees or contractors, be careful when hiring remote workers. Local payroll laws and tax requirements can vary drastically by location.

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