Contractor vs. Employee: Pros, Cons, And Which To Hire
While they may be tasked with similar work, legally there is a difference between independent contractors vs employees. Additionally, you’ll likely think about and utilize them differently within your organization as well.
This article will help you understand the key differences between hiring an independent contractor vs employee and the pros and cons of each.
If this is your first time hiring, I suggest using recruitment solutions for small businesses to help clarify roles and streamline the hiring process.
What Is An Independent Contractor?
Independent contractors are typically hired on a short-term basis to work on specific projects and are treated differently within organizations compared to regular employees. These workers are often experienced professionals brought in for their specialized expertise.
Under various legal frameworks, such as the IRS guidelines, the Fair Labor Standards Act (FLSA), and common law principles, there are specific rules that help determine whether a worker is classified as an employee or an independent contractor. These classifications are important for determining payroll, benefits, and other legal responsibilities.
IRS guidelines
The IRS provides clear criteria to distinguish between employees and independent contractors. It primarily focuses on three categories: behavioral control, financial control, and the type of relationship.
If an employer has significant control over how the worker performs tasks, including providing specific instructions, access to company data and tools, or requiring set hours, that worker is likely to be classified as an employee.
Independent contractors, on the other hand, typically control how and when they perform their work, and are responsible for their own business expenses.
Fair Labor Standards Act (FLSA)
The FLSA emphasizes factors like the level of independence a worker has and the permanency of the relationship.
Employees are typically seen as being more dependent on their employer for continued work, whereas independent contractors maintain autonomy and often have multiple clients or contracts.
Employees are also entitled to minimum wage, overtime pay, and other labor protections under the FLSA, while independent contractors are not.
Common law
Many jurisdictions also rely on common law tests to classify workers. These tests look at factors such as whether the work performed is an integral part of the employer’s business, the duration of the relationship, and whether the worker supplies their own tools and equipment.
Under common law, a key question is whether the worker is economically dependent on the employer or in business for themselves.
Understanding and adhering to these frameworks is essential for determining proper worker classification. Misclassifying a worker as an independent contractor when they should be classified as an employee can lead to significant legal and financial consequences, including back wages, unpaid benefits, and penalties for failing to withhold taxes.
Difference Between An Independent Contractor vs Employee
Independent contractors and employees are fundamentally different types of workers in the eyes of Canadian and US labor laws, income tax laws, and workers' compensation regulations.
Tax agencies in both Canada and the US—the Canada Revenue Agency (CRA) and the Internal Revenue Service (IRS), respectively—refer to independent contractors as “self-employed” individuals.
Both Canada and the United States make clear distinctions in the working status between a self-employed contractor and an employee, particularly as they relate to the following:
| Canada | USA |
|---|---|
| Employment insurance (EI) benefits | State unemployment insurance (UI) benefits |
| Canada Pension Plan (CPP) benefits | US Social Security benefits |
| Workers’ compensation coverage | Workers’ compensation coverage |
| Personal income tax and self-employment tax regulations for Canada | Personal income tax and self-employment tax regulations for the United States |
Companies that choose to hire an employee are responsible for all of the items listed above.
For example, they need to ensure the correct tax withholdings and deductions (e.g. EI, CPP, FICA, Medicare tax) are made when the employee gets paid.
A company will not do this for a self-employed worker. It’s the contractor’s responsibility to pay the appropriate taxes and ensure they have appropriate medical and workers’ compensation coverage.
Similarly, employment and labor laws, such as Canada Federal Labour Standards and the US Fair Labor Standards Act, apply to employees but not independent contractors. These laws govern everything from hiring and termination practices to working hours and vacations.
Criteria for classification
Both tax agencies refer to independent contractors as “self-employed” individuals.
In both countries, the distinction between independent contractors and employees hinges on three key criteria, which we will lay out as it is defined by the IRS: behavioral control, financial control, and the nature of the relationship.
Behavioral Control
Behavioral control refers to the degree of oversight and direction the employer or client has over how the worker performs their job. Employees are generally subject to detailed instructions on when, where, and how they perform, how they're assigned tasks and what tools they use to complete them.
In many cases, it's common for an employee to be required to adhere to a company’s daily schedule and work under direct supervision.
In contrast, independent contractors enjoy far greater autonomy. They control their own work methods, decide how tasks are completed, and can determine their work schedules. Contractors may also work from any location they choose, often using their own tools or equipment.
Additionally, independent contractors may have the option to hire their own staff or subcontract certain tasks, further demonstrating their independence from the hiring company.
Financial control
Financial control focuses on how much financial risk and responsibility the worker bears. Employees typically experience minimal financial risk. They receive a regular paycheck, often on a fixed schedule, and their employer covers job-related expenses such as travel, materials, and equipment. Employees do not invest their own money into their work and are usually reimbursed for any work-related costs they incur.
Independent contractors, on the other hand, operate more like businesses. They are responsible for their own financial investments in tools, equipment, and supplies needed to complete their tasks.
Contractors often invoice clients for their work, which means they control their income but also face risks such as delayed payments or non-payment. Independent contractors are responsible for their own business expenses and are not reimbursed for most costs associated with their work. This higher level of financial risk and the need to manage expenses and earnings highlights that they are separate from the business.
Nature of the relationship
The third IRS criterion looks at the overall interaction between the worker and the company. This includes factors such as the permanence of the relationship and whether the worker receives benefits like health insurance, vacation time, or pension contributions.
- Employees typically have a long-term, ongoing relationship with their employer. They may receive benefits such as paid time off, health insurance, and pension contributions. Employment contracts or policies often outline job security, indicating that the relationship is expected to continue indefinitely, unless terminated for specific reasons. Employees also have legal protections under labor laws such as the US Fair Labor Standards Act (FLSA) and Canadian Federal Labour Standards.
- Independent contractors, by contrast, often work on a project-by-project or temporary basis. They may be hired to complete a specific task or project, and once the work is completed, the relationship usually ends. Contractors are not eligible for company benefits like health insurance or paid leave and generally work with multiple clients simultaneously. Contracts with contractors often define the terms of the relationship and specify the temporary nature of the engagement.
Contractor vs Employee Pros And Cons
The following table summarizes the pros and cons of an independent contractor vs. employee, with an ‘X’ indicating an advantage of one over the other.
| Employee | Contractor | |
| Long-term commitment | Yes | No |
| Ease of termination | No | Yes |
| Quickly change responsibilities | Yes | No |
| Pay rates/compensation | Yes | No |
| Overhead costs (benefits, insurance, equipment etc) | No | Yes |
| Management time required | No | Yes |
| Training requirements | Yes | No |
| Level of control over work | Yes | No |
There's significant risk in taking on a contractor that you intend to have working closely with employees. Misclassifying workers as independent contractors when they should be classified as employees can expose employers to significant liability and legal penalties.
To give you an example, if a misclassified contractor is injured on the job, they may be able to sue the company for benefits such as workers' compensation, which they would have been entitled to as an employee.
Employers who fail to properly classify workers face penalties for noncompliance with labor and tax laws, including fines, back pay for wages, unpaid overtime, and the cost of benefits such as health insurance or unemployment contributions. The IRS, Canada Revenue Agency, and other government agencies may also impose penalties for failure to withhold the proper taxes.
Benefits Of Contractors vs Employees (And Vice Versa)
Hopefully, by now you have a rough idea of the pros and cons of a contractor vs. employee and why you might hire one over the other.
There are always exceptions to the rule, but below are some of the typical advantages and disadvantages of each.
Employees are more committed
Due to their status, permanent employees might be more vested in the long-term success of your organization.
Independent contractors will also often work with more than one client at a time and set their own priorities on which clients to focus on.
On the other hand, contractors also bear financial risk, which may motivate them to deliver high-quality results.
Contractors are focused
The work you need doing may only require a short time commitment and have a defined beginning and end.
If so, it doesn’t make sense to take on the financial and time burdens of hiring and then firing an employee unless you anticipate having multiple similar projects with work that will go on indefinitely.
Contractor relationships may be easier to terminate
It may be easier to fire a contractor vs terminating someone’s employment if things aren’t working out. However, this relies on having specific clauses written into the agreement that simplify termination.
Employee’s responsibilities are more adaptable
It is easier to quickly change the scope of an employee’s role, goals, and/or objectives than it is with a contractor. This gives the business owner flexibility to rapidly adapt to changing project priorities or unforeseen events such as managing a crisis.
Salary vs total compensation
Because of the temporary nature of their work, the higher degree of specialization, and the experience that they bring, you will pay contractors a much higher hourly rates than employees doing similar work.
On the other hand, by hiring a contractor you avoid paying for employee-related costs such as health insurance, employee benefits, paid time off, retirement plans, access to wellness programs and office supplies and equipment.
The hourly rates and the length of time the person is working will impact the total overall cost. In many cases, the overall cost of an employee can be significantly higher than a contractor.
Contractors (can) save time
A contractor can save you time that you would ordinarily spend on getting an employee onto the payroll, setting up their workspace, etc. Onboarding contractors, while similar to an employee is a bit simpler, as is establishing their KPIs.
Also, because you don’t have behavioral control over how they are doing work, there is less time required to manage them.
On the other hand, when you invest time into getting an independent contractor up to speed on a project, that time investment is lost if you end up having to hire subsequent contractors to complete or correct previous work.
Additionally, contractor payroll can become a separate function from your regular payroll, adding a layer of complexity to admin work. (If that's what you're hoping for, try this list of the best contractor payroll software on for size.)
Contractors often require less training
An independent contractor requires less training since they rely on their own experience and expertise to do the work and have control over how work will be done.
Employees can be easier to control
You may simply want to have a higher degree of control over how work gets done, in which case it makes more sense to hire an employee vs. a contractor. In exchange for giving up control, employees receive a lot of rights and protections contractors don't.
For example, contractors are not protected under anti-discrimination laws under the Civil Rights Act or Canadian Human Rights Act which safeguards employees from unfair treatment based on race, gender, age, or other protected characteristics.
Classification Tips
Misclassifying an employee can have some pretty dire consequences, with both formerly contracted employees and the Department of Labor or IRS dragging your legal team into court.
They may also conduct an audit of your classification practices, with the results playing out publicly and damaging your reputation as an employer.
So how do you avoid this? The first step is to be proactive about establishing classification practices.
Follow IRS and DOL guidelines on the determining factors of behavioral control, financial control, and the nature of the relationship to ensure proper classification.
If there is any uncertainty about how to classify a worker, employers can file IRS Form SS-8, which allows the IRS to officially determine the worker's status. This can provide clarity and protection for both the business and the worker.
Be aware of industry oversight
Certain industries, such as healthcare and education, are subject to additional oversight and compliance requirements that go beyond standard labor laws.
In these sectors, employees must adhere to industry-specific regulations related to licensing, certifications, and safety protocols. For example, healthcare workers may be required to maintain specific medical licenses and undergo regular training to comply with government health and safety regulations.
Similarly, educators often need to meet state or provincial certification standards and background checks to ensure compliance with local educational policies.
Employers in these industries must ensure that their employees not only meet general employment laws but also the additional regulatory requirements specific to their field. Failing to comply with these industry regulations can lead to significant legal penalties, loss of accreditation, or even shutdowns.
Stick to the law
Some employers will innocently acquiesce to the request of the worker to be an independent contractor and vice versa, the employer will insist on an independent contractor relationship and force it on the worker.
Whether there is informed consent or coercive “consent” the parties are ignoring the control factors which the law will look to and determining employee instead of independent contractor status.
Regardless of intent or innocence in motive there can still be improper classification.
Another cause for confusion is that there are different tests for independent contractor status between the federal government and the states.
Within the states, there can be different tests to determine whether a worker is eligible for unemployment or workers compensation or overtime.
The tests tend to change based upon legislative enactment at different interpretations, as well as rules propagated by different administrations.
In other words, a worker might be an independent contractor under federal law, but an employee for purposes of state unemployment compensation. The rules in one state may be completely different from the rules in a neighboring state.
How Can Professionals Like Lawyers And Accountants Help?
In a recent article on hiring your first employee, I suggested that founders and small business owners make sure they have access to a good lawyer and accountant.
Unless you enjoy reading labor codes and employment regulations in your spare time (I mean, who doesn’t?), I strongly suggest finding professionals who can help you in dealing with more complex issues.
Consulting with attorneys or HR experts early on will help you ensure workers are classified correctly. These professionals are well-versed in employment laws and can help you interpret CRA, IRS, and DOL regulations.
While attorneys can help you navigate common law practices that affect worker classifications, accountants can assist with proper tax withholdings or self-employment tax guidance.
With that said, a lot of the compliance headaches around classification can be eased simply by laying a good foundation for the relationship with both contractors and employees.
The role of software in worker classification
Alongside professional advice, the right workforce management software can play a key role in mitigating the risks of misclassification. By tracking key metrics like hours worked, tasks completed, and payment structures, software can provide data that helps determine whether a worker fits the criteria of an employee or contractor.
These tools can also help manage contracts, tax filings, and worker statuses, reducing administrative burdens and ensuring compliance with tax and labor regulations.
Employers can use HR software to flag potential misclassification issues early on, enabling them to adjust contracts or work practices as needed. It's recommended that you combine this technology with the expertise of your legal team.
They can assist you in interpreting employment laws and CRA and IRS tax regulations; help you understand their implications and how they apply to you; and provide insight into common law practices that might affect you.
Utilizing Independent Contractors AND Employees
Many organizations will hire a mix of both independent contractors and employees at some point along their journey.
Tools such as contractor management software help with hiring, overseeing, and paying contractors and ensuring compliance with regulations. They simplify coordination, improve efficiency, and help manage contractor-related tasks and projects effectively.
If you're thinking of hiring outside the borders of your state or country, you might be at the point of investigating what is a professional employer organization or trying to understand employer of record relationships.
Each can help if you prefer the idea of permanent staff and want to stay on the right side of employment law across geographies while reducing some common human resources headaches.
Take a look at our shortlist of the best professional employer organizations and the best employer of record companies to find the right partnership for your employee management needs.
And if you're just trying to keep up with all the latest developments and gain insights on overcoming staffing challenges, you might want to consider attending one of the many staffing conferences focused on these very challenges throughout the year.
DISCLAIMER: The information provided in this content is for general informational purposes only and should not be considered legal or HR advice. Every business and situation is unique, and the rules and regulations surrounding employment and worker classification can vary by location and industry. We strongly recommend consulting with qualified legal, HR, or tax professionals for personalized guidance tailored to your specific needs and circumstances.
