Independent Contractor vs Employee: What's the Difference?

In today's job market, businesses and job seekers alike are no longer relying on a traditional 9 to 5 work life. Instead, they've adopted a more flexible approach to employment through short-term work arrangements.

That's why, no matter the kind of business you run, understanding the difference between employees and independent contractors is a crucial part of hiring. While it's true that both may share some similarities, the legal implications and responsibilities associated with each role are vastly different.

What we'll cover

1. Independent contractor definition
2. Employee definition
3. Key differences between an employees and independent contractors
4. Worker misclassification consequences 

What is an independent contractor?

Think of independent contractors as the freelancers of the working world. Independent contractors are individuals who provide services to a company or organization on a contractual basis. They're not considered employees and typically work on specific projects or assignments.

Independent contractors can be found across various industries – from graphic designers and writers to consultants and IT specialists. Their expertise makes them valuable assets for companies looking to tap into specialized skills without committing to long-term employment contracts.

What is an employee?

Employees are often considered part of the core workforce, meaning they have a long-term commitment to their employer. Unlike independent contractors who have more flexibility in how they complete their work, employees must generally adhere to specific working hours and follow established company policies and procedures.

Independent contractor vs employee: Key distinctions

When it comes to working arrangements, understanding the difference between an independent contractor and an employee is crucial. These two classifications carry significant implications for both workers and employers.

An independent contractor is a self-employed individual who provides services to clients on a contract basis. They have more control over how they complete their work, often setting their own hours and choosing their projects. In addition to that, independent contractors are responsible for paying their own taxes and do not receive benefits such as health insurance or retirement plans from the company they work with.

On the other hand, an employee works directly for a company under an employment contract. Generally, employees have less autonomy in determining how they perform their tasks and adhere to specific instructions provided by the employer. What's more, employees typically receive benefits like paid time off, healthcare coverage, and access to retirement plans.

The distinction between an independent contractor and an employee lies primarily in the level of control exercised by each party involved. This is usually determined by assessing the following factors.

1. Behavioral control

The first big difference between an independent contractor and an employee is their level of independence. While an employee works under the direct control and supervision of an employer, independent contractors have more autonomy over their work. This includes the ability to set their own schedules, choose when to work, and how to finish tasks.

2. Nature of the relationship

Independent contractors usually work on a project or task basis. Employees, on the other hand, are engaged in an ongoing, long-term relationship with the employer.

3. Flexibility

Employees are generally expected to dedicate their work time exclusively to their employer. However, independent contractors have the flexibility to take on multiple clients and projects at the same time.

4. Finances

If you hire a full-time employee, they have to go on your company's payroll. This means you have the obligation to pay them a regular salary, withhold taxes, and provide them with mandatory employee benefits.

A contractor, on the other hand, gets an agreed-upon wage for their services, but no taxes are withheld. This is because contractors are responsible for paying their own taxes, including federal income taxes and self-employment taxes. Any benefits, including health insurance, are also the contractor's responsibility.

5. Equipment and resources

Under an employee agreement, most companies require their employees to use company equipment (such as laptops and phones) for work. And while some companies require contractors to use company equipment as well (usually for security reasons), this can lead to misclassification problems. From a legal standpoint, it is safer to allow contractors to use their own tools, but it poses other threats, such as security and data protection.

The consequences of worker misclassification

Knowing the difference between an independent contractor and employee is the first step towards avoiding worker misclassification. It is important to note that worker misclassification can have significant legal, financial, and operational consequences for both the employer and the misclassified worker.

Violations of labor laws

Misclassifying employees as independent contractors puts the employer at risk of violating labor laws. Similarly, in the realm of digital transformation in insurance, companies must navigate complex regulatory environments to innovate while remaining compliant.

Depending on the country, employees can be entitled to minimum wage, overtime pay, and protections against workplace discrimination. 

Since the law usually treats contractors as independent business owners, employers don't have to give them employee benefits. However, not paying attention to government regulation regarding who is considered to be an employee versus contractor can result in breaking the law. Whether this is intentional or not, employment law violations can result in fines, penalties, and legal fees.

Employment claims

Besides potential problems with the government, misclassification can also lead to issues with the misclassified workers themselves. Workers that believe they have been misclassified may sue their employers seeking back pay, unpaid overtime, and other benefits they have the right to.

Tax liabilities

Withholding of income taxes, social security, and health insurance from employees' wages is usually the employer's responsibility. Workers who are misclassified may not be withheld these taxes, resulting in underpayment or back taxes.

Unemployment insurance

Misclassified workers are financially vulnerable in the case of job loss or workplace injury. This is because misclassification leaves them ineligible for unemployment insurance or workers' compensation benefits.

Back wages and employment benefits

If misclassified workers are later determined to be employees, employers may be required to pay back wages and overtime. What's more, employers may be liable for retroactive employee benefits, such as health insurance and retirement contributions.

Reputation and employee relationship damage

Misclassification cases can damage the employer's reputation, especially if the case becomes public or attracts media attention. In addition to that, if employees perceive unfair treatment or a lack of compliance with labor laws, misclassification disputes can strain employee relations and reduce morale.

Final thoughts

Accurate classification of workers as either independent contractors or employees is imperative in order to maintain compliance with labor laws and circumvent possible legal and financial penalties. Misclassification can lead to costly disputes and liabilities, so it's important to base this classification on several criteria, such as the amount of control the employer has over the work performed, the scope of the relationship, and the autonomy of the worker.