Independent Contractor vs. Employee: 5 Main Differences

ByJulija A.
April 20,2022

If you were just to observe an office where an independent contractor and an employee were working side by side, you’d be hard-pushed to see any difference between them. Both would be typing at computers, going to meetings, and using the bathroom. 

Even so, they’re not the same. There are both practical and legal differences between them. 

In this post, we ask: Independent contractor vs. employee – what’s the difference? We then explore the pros and cons of each and some of the penalties you might face if you classify workers incorrectly. 

Employee vs. Independent Contractor

Employees are defined as workers on the company’s payroll who receive regular wages and benefits in exchange for loyalty to the organization. An employee, for instance, can’t work for both Citigroup and JPMorgan at the same time. They must also adhere to company guidelines, including all of the stipulations in the employee handbook

Contractors, on the other hand, are independent workers who get paid for completing projects. They don’t receive any perks or benefits (besides their pay), and they are not on the company payroll.

Contractors usually run their own legal business entities, such as limited liability companies. Organizations buy their services “off the shelf,” as and when they need them. If the contracting company sees fit, it can simply cancel them without having to offer any redundancy pay or advanced notice.

Contractors sign contracts with businesses hiring them. These set out what the company expects, the deliverables, and how long the work will go on for. Contracts can be short-term, lasting just a few weeks, long-term, or indefinite, depending on the underlying brand’s business model.

Businesses often hire contract workers because it’s cheaper than taking on full-time employees. For instance, when companies hire gig workers, they don’t have to pay health insurance, vacation time, 401(k) contributions, or any other benefits. They just pay the fee that the contractor asks for. 

Independent Contractor vs. Employee Checklist

In this section, we explore the differences between employees and contractors.

Pay and Taxes

Companies pay employees and contractors differently. As discussed, employees are on the company payroll and typically receive either a fixed monthly salary or a figure determined by their hourly rate of pay.

Contractors, on the other hand, aren’t on businesses’ payroll. Instead, companies pay them in a similar way to how they might pay a vendor by making a bank transfer or sending them a check in the post. 

There are also differences when it comes to taxes. Firms tax employees on behalf of the IRS by automatically deducting anything they owe from their paychecks. They then provide breakdowns of taxes paid (such as Social Security, Medicare, and federal income tax) on the pay stubs they hand out to employees at the end of the month. 

Sole proprietors and partners, on the other hand, must pay contractor taxes independently, according to federal law. Companies they work for don’t pay or hold any taxes on their behalf. As such, gig workers are entirely responsible for paying their own taxes (though, in most cases, they hire accountants to do it for them). 

Benefits are another point of departure. Employees typically receive financial and nonfinancial perks as part of their pay packets. Employers, for instance, might make contributions to their health savings accounts, health reimbursement accounts, or flexible spending accounts or offer them free gym memberships, company cars, and so on. 

By contrast, contractors don’t receive anything other than their agreed-upon wage. If they want any of the above perks, they must buy them themselves. 

Reasons for Hiring

Companies hire employees and contractors for different reasons. The main motivation for employing a worker is to gain their loyalty and leverage their skills daily, long-term. The reason for this is simple economics: It’s expensive for firms to continuously go to the market and hire the skills they need on a job-by-job basis, so bringing someone in-house cuts costs. 

On the other hand, firms typically hire contractors when they require their niche expertise for a particular project. For instance, it’s common for contractors to work for firms for a couple of months and then leave once they obtain certain milestones. 

Furthermore, contractors have less loyalty toward the companies they work for because they’re always on the lookout for the most lucrative projects. 

Employment Flexibility

Employees have a single employer (unless they have a side gig) and are subject to their employer’s rules. Contractors, on the other hand, work for many firms, either concurrently or sequentially throughout the year, depending on the type of work they do. 

Of course, there are independent contractor pros and cons associated with this. On the plus side, they can take time off work whenever they like. However, if they do, they won’t get paid, which is a negative compared to a “standard” employee.

Training

As you might expect, there are also significant differences in training and onboarding between independent contractors and employees. Contractors, for instance, don’t get much (if any) onboarding at all. That’s because they’re not joining the company long-term. Employees, on the other hand, may receive long on-ramps that introduce them to every aspect of the business, including the culture, hoping that they will stick around for the long haul.

Training is also different. Companies expect independent contractors to arrive with fully-fledged skills right off the bat, whereas they may view employees as more of a work in progress, offering professional development as a job perk. 

Autonomy

Lastly, there are significant differences between the level of autonomy afforded by regular employment and self-employment contracts. 

Employees must perform work according to the instructions of the employer. For contractors, it’s different. Firms assign them projects, but it’s entirely up to them whether they take them on or not. Moreover, companies tend to exert less control over where and how the project is completed. Contractors, for instance, don’t have to turn up at the office at set hours or dedicate certain times of day to particular tasks.

Classifying Workers

The IRS looks for specific factors that indicate whether someone working for you is really an employee. Therefore, it’s critical to get the distinction right. If you don’t, the IRS or workers may take legal action against you.

Here are the questions that’ll point you in the right direction:

  • Where does the worker do most of their work? If workers spend most of their time in company offices, then the IRS will likely classify them as de facto employees. By contrast, if they work remotely, they’re more likely to be independent contractors. 
  • When does the worker work? Employees have to work set hours throughout the week, according to a contract, whereas contractors don’t. If you demand that contractors work during set periods, then you may be treating them more like employees in the eyes of the IRS.
  • Is the worker doing full-time, continual work? A worker may also be an employee if they’re doing full-time, continual work for you. Remember, most contractors work for their business clients for a limited time and then move on. If they remain for many years, the IRS may interpret that as a sign that they are actually employees. 
  • Is the worker paid monthly? Another sign that a worker is an employee is if you pay them a set amount monthly instead of on a “per project” basis. The IRS may view such payments as being suspiciously similar to a regular salary. 
  • Does the company pay for travel? Companies will usually pay for employee travel costs because they can deduct them from their expenses. Independent contractors, on the other hand, are usually required to pay for their own transport. If companies pay for contractor transport, the IRS might consider this evidence they are actually de facto employees. 

In summary, knowing the right classification for your workers is essential. If you misclassify, you may have to pay both back taxes and fines to the IRS. The size of the bill will correspond to the number of Form W-2s that you failed to file because you didn’t correctly classify an independent contractor as an employee. 

Furthermore, if the IRS believes you deliberately and persistently misclassified workers, you may face criminal penalties. These could include fines, jail time, and damages litigation by workers. 

Employee Pros and Cons

Let’s take a look at some of the positives and negatives associated with hiring an employee. 

Pros of Hiring Employees

  • Part of a team and often want to go the extra mile to advance their careers
  • A sense of loyalty and duty toward the firm
  • Able to perform routine tasks over long periods
  • Can take on extra work when the need arises

Cons of Hiring Employees

  • Training and professional development can be expensive
  • Salaries must be paid like clockwork, regardless of the business’s cash flow position
  • Perks and other employee-related expenses can add to the cost of hiring
  • Recruitment and interview processes can take a long time

Pros and Cons of Independent Contractors

Now, let’s take a look at some of the pros and cons of independent contractors: 

Pros of Hiring Independent Contractors

  • Save money overall because you’re not committed to paying any benefits or salary
  • Easily hire the right person for the task without the need for additional training
  • Gain greater flexibility; if a contractor isn’t a good match, there’s no need to hire them again
  • The contractor takes care of all the permits and licenses they need; it’s not the business owner’s responsibility

Cons of Hiring Independent Contractors

  • Some loss of control over how they perform tasks
  • Difficulty closely monitoring their work and assessing the quality of their contributions
  • Lack of company loyalty
  • Independent contractors own the copyrights to their work unless you write up an agreement stating otherwise
  • Hired short-term and may require administratively costly re-hiring in the future

Conclusion

Essentially, the difference between an independent contractor and an employee comes down to the relationship of the worker to the firm hiring them. If they receive regular wages, follow instructions of senior managers, and work at the employer’s place of business, then they are probably an employee. However, if they work relatively independently, don’t receive benefits from the employer, and operate remotely, then they are more likely to be a contractor. 

Correctly classifying workers is essential. Failing to do so properly can result in having to pay hefty back taxes and fines to the IRS. Furthermore, wrongly classified employees may litigate against you. 

Frequently Asked Questions
What is an independent contractor?

An independent contractor is a self-employed worker who is not on the company’s payroll. They’re allowed to work for multiple companies at the same time, charge prices for their services, work autonomously, and choose how much time they take off. Employees, on the other hand, can only work full-time for one company, don’t set prices for their services, and must follow the employee handbook rules for time off.

How do you pay taxes as an independent contractor?

Independent contractors pay taxes by liaising with the IRS directly. Most sole proprietors complete a Schedule C and then pay income taxes on the total profits they make. Company payroll automatically deducts employee taxes from monthly pay stubs.

How do you pay a salary to your employees?

There are several ways you can pay a regular salary to your employees: check, cash, direct deposit, and mobile wallet. Of these, direct deposit is the most common and convenient.

About the author

Julia A. is a writer at SmallBizGenius.net. With experience in both finance and marketing industries, she enjoys staying up to date with the current economic affairs and writing opinion pieces on the state of small businesses in America. As an avid reader, she spends most of her time poring over history books, fantasy novels, and old classics. Tech, finance, and marketing are her passions, and she’s a frequent contributor at various small business blogs.

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Voice Search Will Become a Big Deal As voice-activated assistants like Amazon Alexa and Google Home become more common, we expect voice search to become more prominent in global eCommerce trends. Voice search allows for voice input, which is faster and often more convenient than typing. As statistics indicate, about 75% of US households will own at least one smart speaker by 2025, making voice search an important factor in eCommerce.  As the use of voice-activated assistants grows and as they become an integral part of eCommerce’s future, we expect businesses will optimize their eCommerce sites for voice search. This means using natural language instead of keywords, including long-tail keywords that are more likely to be spoken than typed, and making sure that product pages are listed when someone searches for relevant keywords. It will also become more critical for businesses to provide concise and accurate information on their product pages. This is because people are more likely to get frustrated with a voice-activated assistant if they have to keep asking for clarification on product descriptions. Conventional Payment Options Will Take a Back Seat As the world becomes more digital, we expect to see a shift from traditional payment methods to newer, more secure methods such as mobile payments and cryptocurrencies. Unlike recent B2B eCommerce trends, this one will have a more profound and lasting impact on the way businesses interact with customers.  With a variety of ways to pay for goods and services online, customers will have more choice and flexibility when it comes to how they make purchases. We expect mobile payments to become more popular as people become more comfortable using their smartphones to make transactions. Contactless payments have become common during the pandemic, and established players such as Apple Pay, Google Pay, and Samsung Pay are likely to benefit from this trend. Cryptocurrency is another payment method that is gaining popularity, particularly among younger generations. Bitcoin payments, one of the major new trends in eCommerce shopping, have been on the rise lately. As more people become aware of cryptocurrency and how to use it, eCommerce customers will have more options when it comes to how they make payments. Headless and API-Driven Commerce is Gaining Momentum Headless commerce is an architecture that decouples the back-end systems from the front-end. This allows businesses to build their eCommerce store using any programming language and framework they want. API-driven commerce is a similar concept, but it takes things one step further by allowing businesses to connect their eCommerce store to any third-party service using APIs, a type of software that allows two applications to communicate with each other. This eCommerce industry trend is gaining momentum because it gives businesses more flexibility and control over their stores. Companies can also get the advantage of the incorporated SEO, content marketing tools, and digital experience features. Finally, back-end developers and front-end developers can work independently of each other, which speeds up the development process. Product Videos Will Become More Popular As broadband speeds continue to increase and more people watch videos on their smartphones, customer engagement through product videos will continue to grow. Short video content is a great way to show off your products in a way that is more engaging than traditional product photos. They are also a great way to showcase how your products can be used in real-world scenarios directly from your eCommerce store. Unlike photos or descriptions, video content can quickly grab a viewer’s attention and give them an idea of what your product is all about. If you want to stay ahead of the curve, you need to start thinking about how you can use video content to showcase your products or services effectively. Conversion Strategies Will Focus on Building Trust In order to convert leads into customers, businesses need to focus on building trust. Multi-channel selling, Facebook advertising, and Instagram marketing are great ways to convert leads into customers, provided you focus on building trust with your target audience.  As recent online sales trends indicate, consumers are more and more skeptical of advertising and are looking for brands they can have confidence in. This can be achieved in a number of ways, such as by displaying customer testimonials and reviews, social proof, and security seals. Another way to build trust is to offer a money-back guarantee or free shipping. This shows that you are confident in your product and that you are willing to stand behind it. Finally, focusing on transparency (e.g., disclosing your business practices, the manufacturing process, etc.) and building a strong social media presence can also help any business in the eCommerce industry build trust with potential customers. Big Data is a Game Changer Big data is a term used to describe the large volume of data that businesses now have access to. This data can come from a variety of sources, such as social media, website analytics, CRM systems, and more. Big data can be used to improve the customer experience in a number of ways, such as by personalizing the experience, identifying customer pain points, and improving customer service. We've all experienced seeing suggestions on shopping platforms or search engines, and most of us have found them to be pretty accurate. The more data a company has, the better it can cater to its customer's needs, and this will become increasingly important in future eCommerce trends. However, big data carries big challenges as customers are more and more concerned about data privacy. So, businesses need to make sure they are handling customer data responsibly and transparently if they want to keep using it to boost profits. Mobile Commerce Will Continue To Grow Mobile commerce is expected to continue growing in the coming years. According to statistics, mobile devices are used for over 40% of online transactions, their rising popularity indicates that this is one of the trends in online shopping that’s here to stay. Mobile commerce offers a number of advantages for businesses, such as increased reach, shorter buying cycles, and improved conversion rates. It also offers many advantages for customers, including the ability to shop anywhere at any time. If you want to stay ahead of the competition, it’s important to make sure your eCommerce platform is mobile-friendly. This means having a responsive design that looks good on all devices, as well as providing a smooth and easy-to-use mobile shopping experience. Omnichannel Selling Will Become the Norm Omnichannel selling is a term used to describe the practice of selling products through multiple channels, such as brick-and-mortar stores, online stores, mobile apps, and more. This eCommerce trend and approach allows businesses to reach more potential customers and provides a more seamless shopping experience. In the past, businesses have often treated each selling channel as a separate entity. However, this is changing as more and more businesses are adopting an omnichannel approach. This shift is driven by the increasing popularity of online shopping and the need for businesses to provide a more cohesive customer experience. As omnichannel selling becomes more common, it’s important for businesses to make sure they’re building eCommerce websites that can support it. This means having a platform that is integrated with all of your other selling channels and that provides a consistent experience for customers regardless of how they shop.  Environmental Sustainability Will Play a Big Role As we become more and more aware of the impact our consumption has on the environment, sustainability is becoming an important factor in purchasing decisions. Customers that follow new online shopping trends want to know if the products they’re buying have been ethically sourced and if the company they are buying from is taking steps to reduce its carbon footprint. In order to stay ahead of the competition, businesses need to make sure they’re considering environmental sustainability in all aspects of their operations. This includes everything from the sourcing of materials to the packaging and shipping of products. Customers are now more willing to pay extra for sustainable products, so there is a big opportunity for businesses that are able to meet this demand. How To Make the Best Use of ECommerce Trends ECommerce is constantly evolving, and it can be difficult to keep up. However, by staying informed and making sure your eCommerce platform is up to date, you can ensure that your business is able to stay ahead of the competition. To make the most of the latest eCommerce developments, consider the following: 1. Keep Up With the Latest Trends To stay on top of your game, you must be proactive and regularly seek out new information. There is a number of ways to do this, such as reading industry news, following relevant blogs and industry influencers, and attending eCommerce conferences. You can get to know what’s going on in the industry and find inspiration for your own business.  Read up on the research data and statistics that are available on eCommerce growth trends. This can help you understand the current landscape and make informed decisions about where to focus your efforts.  2. Take Advantage of Digital Tools There are a number of digital tools that can help you improve your eCommerce business. From marketing automation software to customer relationship management systems, there’s a variety of features that can make it easier to run your business and provide a better experience for your customers. Check the data and sales figures, and invest in analytical tools so you can understand where your customers are coming from and what they are looking for. 3. Learn From Your Competitors It’s important to keep an eye on your competitors to see what they are doing and how they are reacting to the latest eCommerce retail trends. You can learn a lot from observing their strategies and understanding their strengths and weaknesses. Should they fail, you can learn from their mistakes. If they succeed, you can try to replicate their success. Final Words As the global eCommerce ecosystem continues to grow and evolve, it's important to stay on top of the latest trends. Instead of leaning on traditional shopping methods, more and more consumers are turning to the internet to purchase items. Mobile phones play a big role here, as they provide a convenient way to shop on the go. What's more, consumers are getting more comfortable with new technologies such as AI, AR, chatbots, and voice search. These eCommerce trends in technology are changing the way we interact with eCommerce platforms and retailers. With all that said, we're confident that you now have a solid understanding of the current eCommerce landscape. Just remember to keep your eyes peeled for new trends so you can stay ahead of the curve.
By Danica Djokic · September 15,2022

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