Contractor vs. Employee: Key Differences in the United States

Independent contractors and employees differ in terms of payment, company responsibilities, scope of work, and so much more. Understanding the differences is essential to avoid misunderstandings and misclassification. This article provides an in-depth explanation of the differences so you can hire with confidence

Disclaimer: This content is focused on US employment laws and processes. It does not constitute legal advice. Please consult a legal professional and comply with local employment laws.

What is an employee?

An employee is a worker hired and managed by an employer.

When you hire an employee, they work for you, not for themselves. You formally employ them for a specific job function, for a specific wage or salary, and usually on a set schedule. During that time, they work under your direct supervision and control—you provide them with work-related tasks, and they complete them. 

Regardless of whether your employee is full-time or part-time, or remote or office-based, you generally provide them with an offer letter or employment contract to specify the terms of their employment.

Most companies hire employees with the intent of having a long-term business relationship. And in most cases, within the employment contract, the company outlines a set amount of hours the employee should work per day or week. You’ll pay employees a salary or by the hour and provide them with mandatory employee benefits. 

Avoid worker misclassification risks

Not sure if you should classify a worker as an employee or independent contractor? Follow these three US tests for guidance.

What is an independent contractor?

An independent contractor is a self-employed worker who provides services to a company on a short-term, long-term, or per-project basis. 

Independent contractors work under individual written contracts called independent contractor agreements, so your company doesn’t officially hire them. Many contractors have their own businesses and independent contractor licenses. 

Contractors do not receive a fixed salary. Instead, they receive compensation for their work. Contractors can set a price for their services, specify their preferred payment method, schedule, and deliver their services in alignment with the terms agreed upon in the contractor agreement. 

Unlike employees, contractors aren’t entitled to mandatory benefits and must pay their income taxes. 

The differences between employees and independent contractors

As we mentioned, the business relationship employees and independent contractors have with their employer (or clients) differs in several aspects. 

Hiring and onboarding 

Employees

A potential employee applies to a job within your company and typically goes through several rounds of interviews, often starting with a recruiter, talent acquisition specialist, or someone from your HR department. If the hiring manager or department likes the candidate’s credentials and experience and considers them a good culture add, you offer them the position.

After the employee accepts the job offer, the company typically provides a week or two of onboarding: meeting the team, learning about their responsibilities, software training, etc.

Contractors 

An independent contractor submits an application (which usually includes a portfolio) to a specific department within your company, skipping the initial HR screen. The contractor hiring process is usually faster since there are not several rounds of interviews, and they are recruited directly. The contractor might complete a proposal outlining the services they can provide. You sign an agreement and start working without an onboarding process.

Compensation

Employees

Employees are on your direct payroll. When you sign a contract with them, you agree on the employee’s gross salary, paid monthly, weekly, or bi-weekly. The salary is usually fixed, but the employee may receive bonuses or commissions, depending on their performance. Employees may also have a fixed hourly wage if their working hours are not the same every week.

Check out our guides on global payroll management and small business payroll management to learn more about paying domestic and foreign employees.

Contractors

Independent contractors don’t have a salary. They typically get paid by the hour or after each project, so their income is rarely the same every month.

Often, It’s the contractor’s responsibility to invoice the client to receive payment. Some clients may require their contractors to follow an invoicing and time-tracking policy.

A contractor’s clients do not withhold any tax deductions from their payments as the contractor is responsible for paying their own taxes, health insurance, and retirement contributions. 

Hiring and paying foreign independent contractors can become complicated, as you have to navigate multiple currencies, exchange rates, and bank regulations. Watch the video below to learn how to manage payments and compliance for independent contractors. 

Employer supervision and control

Employees

When you hire an employee, you determine their scope of work, schedule, and working hours. You coach them to complete tasks, develop skills, and take on the financial risk of a failed project. In exchange, employers generally own anything created by the employee during the time of employment. Some employers implement attendance and time-tracking policies for their workforce to monitor their productivity.

Contractors

Independent contractors manage themselves and carry the risk if they fail to deliver the client’s request. Independent contractors decide where, when, and how they complete their projects without the client’s supervision. 

Managing independent contractors typically only involves the client controlling the outcome of the contractor’s work, not the process. However, in some countries, an independent contractor’s work is their intellectual property.

Learn more about protecting intellectual property when you run a global team.

Work schedule and location

Employees

The employer typically determines the work schedule for their employees based on the company policy. In-office employees have fixed working hours (often nine to five), while remote employees have more flexibility in their work schedules.

Contractors

Independent contractors usually organize their own working hours. The client doesn’t control when they complete the work as long as they don’t miss the deadline. Independent contractors almost always work from home (or wherever they prefer).

Tools and equipment 

Employees

Employees use the equipment and tools provided by the company they work for. Whether it’s the office space, furniture, computers, or software, they’re not required to pay to use any of it. Remote work often involves workers receiving a work-from-home stipend to set up a home office. The employer also covers or reimburses their business expenses, such as travel.

Contractors

Independent contractors work with multiple clients in most cases, so they have their own “toolbox” and are responsible for getting their own equipment to do the work. They usually don’t get reimbursement for any business expenses, but employers may elect to provide specialized software or equipment necessary to complete the job.

Training

Employees

When a new employee joins a company, the employer typically provides them with training to ramp up. Employees go through the onboarding process to meet coworkers, learn about the team’s workflows and tools, and gain job-related skills. Employees also often depend on employer-provided learning and development programs for ongoing training and career progression. Training employees is a significant investment. 

Contractors

The situation is different with independent contractors. Independent contractors don’t require training since the client hires them for their expertise. And since these business relationships are usually short-term and the company is only a temporary client, the independent contractor is unlikely to require a structured onboarding process. 

Employment laws and employee benefits

Depending on the workers country of residence, labor laws typically cover employees but not independent contractors.

Employees

In the US, employees receive health insurance, Social Security, workers’ compensation, unemployment tax, and other protections. They also have the right to minimum wage. 

Contractors

Independent contractors, however, are not entitled to mandatory benefits by law. They must typically reserve a portion of their income to cover paid time off (PTO), maternity leave, pensions, and healthcare.

Taxes and tax forms

Employees

In the US, employees typically fill out Form W-4 when they take on a new job. They provide their name, address, Social Security number (SSN), tax filing status, and exemptions. The employer must also file Form W-2 for their employees to report their annual income. The employer covers payroll taxes and FICA taxes (Social Security and Medicare taxes).

Contractors

When engaging a contractor in the US, they must complete and return Form W-9. They’ll provide their name, address, Tax Identification Number (TIN), and certification about backup income tax withholding from the Internal Revenue Service (IRS). 

When filing their own taxes, contractors typically use IRS Forms 1099-NEC, or sometimes Form 1099-MISC if they’re reporting miscellaneous income.

If you’re a US company hiring a foreign contractor, they must fill in Form W-8BEN (for individuals) or W-8BEN-E (for business entities).

Learn more about independent contractor taxes and employment taxes in the US in our article about the differences between 1099 vs. W2 forms.

Termination

Employees

In the US, most employment is at-will. That means employers can typically terminate an employee without providing cause or notice. However, at-will termination is rare elsewhere in the world and can result in penalties. 

Learn how to legally terminate an employee with grace. 

Contractors

Firing an independent contractor is generally easier than terminating an employee, so long as you have a written contract that outlines the termination provisions.

Learn everything you need to know about how and when you can terminate an agreement with an independent contractor.

Minimize misclassification risk

Onboard new hires the straightforward and compliant way. Try Deel’s free AI Worker Classifier Tool to align your hiring strategy with local laws across 15 countries.

Three ways to check a worker’s classification

The IRS has a set of rules that determine a worker’s status. But the IRS’s definition of an employee doesn’t completely coincide with definitions from other authorities like the US Department of Labor (DOL). It’s difficult to pinpoint a single factor determining employment status, so it’s best to comply with all three of the following checks.

IRS guidelines to determine worker status

The IRS uses three broad criteria to assess the employment relationship: behavioral control, financial control, and type of relationship.

Under the Fair Labor Standards Act, these questions determine the nature of the relationship and the subsequent classification and tax liability that goes with it.

Behavioral control

If the employer has the right to instruct how work gets done, this is a sign of an employee. Examples of behavioral control include hours and schedules, location, methods, and tools. For instance, providing training is strong evidence of an employer-employee relationship.

Financial control 

Financial control looks at how much an employer controls the worker’s financial and business aspects of the job. Employees receive a set salary or wage and employee benefits. They almost exclusively work for one employer, especially if they work full-time.

Type of relationship

If a person you hired provides you with a service that is essential or integral to your business, they are likely an employee, as workers responsible for the core business should enjoy statutory benefits (such as health insurance and sick days).

Another factor is the permanency of the relationship. Independent contractors usually work on a short-term basis for pre-determined projects and periods. Any long-term relationship, especially if the scope of work is essential to the business, likely involves an employee.

Department of Labor’s ABC test

The ABC test is a set of guidelines the DOL uses to classify workers as contractors or employees. Authorities may not apply this test in the same way in every state, so in some, it’s also applicable to wages and working hours.

As of this writing, this test is similar to the three criteria used by the IRS. It says that a worker has independent contractor status if:

• The hiring entity doesn’t control or direct the worker
• The worker performs work outside of the hiring entity’s core business activities
• The worker customarily performs the type of work in question as an independent business
  
  

The DOL introduced these rules when the gig economy started booming. There were updates to the ABC test in 2020 regarding types of professions that the law may consider as independent contractors if they meet the mentioned criteria. However, not all states accept this test as the state law—like California, for example—so you’re not obligated to perform it.

IRS’s (retired) 20-factor test

Another way to determine employee status is the common law 20-factor test. This test is no longer officially in use, but it provides concrete questions to help you determine the status of your worker.

Use Form SS-8 to get an official ruling from the IRS

Suppose you and your accountant are still unsure of a worker’s classification. In that case, you can ask the IRS to step in and determine their working relationship by completing Form SS-8 (Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding). It may take at least six months to review your case. A worker who believes they are incorrectly classified can submit Form SS-8 too.

Frequently asked questions about hiring an employee vs. an independent contractor 

Can you change the worker’s status at some point?

Yes. You can change your worker’s status from contractor to employee at any point if you’re happy with their work or if they become crucial to your business. The first step in this process is determining if they meet all the criteria necessary to be an employee by using one of the tests we mentioned in the previous section.

If you determine that you can convert the contractor into an employee, you’ll switch from Form 1099 to Form W-2.

The next step is to notify the worker, give them your official offer, and prepare an employment contract to sign after you negotiate the terms.

After this, your new employee will undergo the usual onboarding process and training. Your job is to help them adjust to their new role and learn how everything works for full-time employees.

Your HR department must collect and store all the necessary information in the new employee record. You’ll no longer be paying your new employee through a W9 Form, so make sure you’re implementing this change when you add them to the payroll. Use our contractor-to-employee conversion policy template to get started.

What are some benefits of working with employees and independent contractors?

Employees provide companies with long-term labor with a high degree of control. You get a dedicated worker you can shape and re-assign as you both see fit.

One of the biggest benefits of hiring independent contractors is access to specialized expertise at a lower cost. Employees typically cost more to hire and retain than independent contractors because you need to cover employment taxes and employee benefits. 

Are there any penalties if you misclassify your workers?

Yes. Misclassifying your employees as contractors is a serious issue in most countries. An employer may face several types of misclassification penalties if the authorities discover they’ve misclassified employees as contractors.

In 2016, Uber paid a $100 million settlement for federal tax evasion because of employee misclassification. Other than financial penalties, there are legal consequences, harmed reputation, and even jail time. Use this assessment to determine if you're at risk of misclassification.

Watch the video below to discover how to fend off misclassification with Deel Shield.   

What is a 1099 employee?

Independent contractors are sometimes referred to as 1099 employees, though they are not technically employees. They’re called 1099 employees because of the 1099 tax form they complete.

What is a contract job?

A contract job is a fixed work assignment that an independent contractor completes. The independent contractor is hired to complete a specific job for a predetermined amount of time and money. Some contract jobs are short-term (one month), while others are longer (one year or more). Determining whether you should become a full-time vs. contract employee depends on your goals, preferred benefits, and ideal work environment.

Confidently engage employees and independent contractors with Deel

Deel helps you easily engage, pay, and manage independent contractors and employees worldwide on a single platform. Deel's Compliance Hub feature is a comprehensive tool automatically monitors and explains the latest and upcoming regulatory changes across 150 countries

With Deel Shield, we classify and hire contractors in 150 countries on your behalf to eliminate your misclassification risk and liability. We also enable you to fund payroll with just a click and automatically calculate taxes without lifting a finger.

Sound like something your business could use? Book a demo to see Deel in action.