Avoid Legal Trouble: What’s the Difference Between a Contractor and an Employee?
As you start to grow your team to support your business goals, there may come a time when you must decide whether to hire an employee or a contractor for certain tasks.
It’s an important distinction to make, since getting it wrong doesn’t just affect your business growth. It could also land you in legal trouble.
So how can you make sure you hire the right person, meet your business goals, and stay on the right side of the law? Read on to find out.
Why is the difference between a contractor and an employee important?
One of the reasons it can be difficult to know whether to hire an employee or a contractor is because the work that they produce can be exactly the same. They are, after all, both types of worker classifications.
While both employees and contractors can complete the same types of tasks for a business, it is the relationship between the business and the worker that is important to understand – that’s where the biggest difference lies.
But why is it so important to know the difference and choose the correct classification?
Well, it’s because if you classify someone who works for you as an independent contractor but treat them as an employee (for example by having them on your payroll and giving them benefits like sick pay and a retirement plan), you risk being charged fines. You could even have to pay back taxes to the IRS.
If the IRS believes the mistake was deliberate, the fines could be even higher. This is because they could view it as you attempting to avoid paying certain taxes.
When you know what type of worker you need for the tasks you have, and how a contractor works versus an employee, you can make the right decision for your business.
What is a contractor?
The key thing to remember about a contractor is that they are part of an entirely separate business from yours. They are hired purely to deliver a particular project for you.
They might be part of a corporation, an agency, or even a business of one, like a freelancer, but they are still a separate business.
When you hire a contractor, you will normally outline the objectives for the work that they deliver to you, the deadline for the work, and the specifications such as the format in which the work must be delivered. However, the contractor has control over when, where and how the work is done.
For example, you might decide to hire a freelance graphic designer to create some social media graphics for your business. You might request that the graphics are delivered as .png files by the end of Q1 so that they can be scheduled during Q2.
The contractor will then decide when and where they work as long as the due date is met and the graphics are delivered in time for Q2. In addition, they can use any design program they want as long as the graphics are delivered in the specified format.
What is an employee?
An employee is someone who works in your business and has a contract of employment with you. Since they work for you, you (or your business) can specify when, where and how their work is done.
Let’s revisit the graphic designer example. This time, you have hired an in-house graphic designer to work for you, and assigned them the task of making social media graphics.
As the employer, you can dictate what hours they must work and their work location – whether that’s in the office, at home, or a bit of both. In addition, you have the ability to tell them what design program they must use to complete the task.
You can learn more about how to decide whether you are ready to hire an employee on our website.
How to know the difference
The best way to know for sure how your new team member should be classified is to figure out who has control over the work that your new hire will complete. If you have more control, they are an employee.
There are three areas that you should think about:
- How the individual completes their work
Is the worker free to choose when they complete the work, the equipment they use, and the location of their work, or is this decided by the hiring business?
- Compensation for the work
Who specifies the financial aspects of the work? This includes how the worker is paid, any additional reimbursements such as for expenses, and which party will provide the necessary equipment to complete the work.
- The relationship between the worker and the business
Is the work a one-off project or will there be an ongoing relationship between the worker and the business? Does the worker receive any additional benefits from the business, such as vacation pay or a pension plan? Is there a written contract specifying each of these points?
As you may have noticed, there can be some gray areas when classifying a worker. It’s not always easy to know for sure whether the person you are hiring should be classified as an employee or a contractor. You can find more information on the IRS website about the difference between the two.
For situations that are especially complex or unclear, consult a lawyer to understand your position and ensure you make the right choice for your business and for the individual you are hiring.
Are you looking for help with hiring your next team member?
Are you ready to hire a new team member for your business, and want to ensure you hire the person who can succeed in the role, make you happy, and positively impact your bottom line?
If you think you might be ready to hire your next team member, the next step is to start looking for the perfect person to grow your team and your business. This can be a complex and daunting process, but we’re here to help you hire like a pro.
Learn how to master the art of hiring and create a process that not only leads you to a pool of your ideal candidates but also points you directly to the person you should hire by downloading your copy of The Hiring Checklist: How to Hire the Right Team for Your Growing Business.