Independent Contractor vs. Employee: Key Differences for Business Owners

Being an employer comes with a lot of responsibilities: there’s the subject of taxes, insurance, training, and a whole range of other obligations to your employees. However, not everyone who works for you needs to be an employee. Some roles may be better suited to be filled by an independent contractor rather than a traditional employee.

So, what exactly is an independent contractor? In simple terms, an independent contractor is a self-employed individual who offers services to others without being part of their business. This distinction becomes crucial when deciding how to hire, especially if you’re looking to optimize costs, manage compliance risks, and be flexible in your hiring approach. Let’s dive deeper into what sets independent contractors apart from employees.

Legal GPS Pro

Protect your business with our complete legal subscription service, designed by top startup attorneys.

• ✅ Complete Legal Toolkit
• ✅ 100+ Editable Contracts
• ✅ Affordable Legal Guidance
• ✅ Custom Legal Status Report

Learn more

Understanding Independent Contractors

An independent contractor is essentially their own boss. They run their own business, offering specific services to others. Unlike employees, independent contractors are not tied to your company structure and are free to provide services to multiple clients at any given time. This arrangement gives them a level of autonomy and flexibility, but it also changes the way they—and you—are treated under the law.

To make this clearer, let’s look at some of the key differences between an independent contractor and an employee. We’ll explore these distinctions in categories like control, employment laws, liability, payment, and more.

Control Over Work

One of the most important differences between an independent contractor and an employee is the level of control you have over their work.

For an employee, the employer exercises control over both what work is done and how it is done. Employees typically follow set schedules, work in defined locations, and use methods dictated by their employer. The employer controls the process, tools, and even the specific working hours.

On the other hand, an independent contractor has control over how they complete their work. The person or company hiring them can only dictate the end result. Independent contractors can decide on their working hours, methods, and tools they need to use to complete the job. This lack of control gives contractors flexibility but also means they are not bound by internal company policies as much as employees are.

Example: If you hire a graphic designer as an independent contractor to create a logo, you can specify the outcome (e.g., “a logo that represents our brand”), but you can’t tell them what tools to use or set a 9-to-5 working schedule for them.

Another Example: A freelance writer hired to create content for a blog can work from anywhere and at any time. You can set deadlines and provide guidelines, but you can’t dictate their daily schedule or the exact method they use to complete the writing.

Employment Laws & Protections

Employees are entitled to a wide range of protections under state and federal law, including minimum wages, overtime pay, worker’s compensation, and other benefits. Employers also contribute to Social Security, Medicare, and unemployment insurance for their employees.

Independent contractors, on the other hand, are not entitled to these benefits. Their working terms are based solely on their contractual agreement, which can lead to greater flexibility for both parties, but with fewer safeguards for the contractor.

Example: If you have 49 employees and you hire a contractor, you are not required to offer benefits like the Family and Medical Leave Act (FMLA), which applies to companies with 50 or more employees. This flexibility can help businesses save money on compliance costs.

Another Example: Independent contractors do not receive health insurance through the hiring company, which can save the business significant costs. However, this also means contractors need to arrange their own health coverage.

Risk of Liability

With employees, an employer can be held liable for their actions during employment, a concept called "vicarious liability." If an employee causes harm or damages while doing their job, the employer can be sued.

With independent contractors, however, there is no such automatic liability. Contractors are generally responsible for their actions unless the employer was negligent in hiring or supervising them.

Example: If a contractor plumber you hired makes an error that leads to a flood, the contractor (not your company) would typically be held responsible for damages.

Another Example: If you hire an independent contractor to install electrical wiring and they make a mistake that leads to a fire, the contractor is usually liable for the damages. However, if you knowingly hired an unqualified electrician, you could share some liability for negligence.

Term & Payment Structure

Employees often have an ongoing relationship with the employer, working for an indefinite period. They are paid regularly (hourly, bi-weekly, etc.), and their wages are often subject to income tax withholding.

Independent contractors are typically hired for a specific project or fixed period. They are paid by the project or task completed and are responsible for their own taxes, which means less paperwork for the business hiring them.

Example: You might pay an independent contractor a flat fee to develop your company website, rather than hourly. This allows both parties to set clear expectations for the scope and cost of the work.

Another Example: A landscaping company might hire an independent contractor to complete a large installation project. The contractor is paid a set amount for the project, regardless of whether it takes them one week or one month to complete.

Intellectual Property Ownership

When an employee creates something in the scope of their employment, the employer automatically owns the intellectual property rights to that work. For independent contractors, intellectual property ownership generally stays with the contractor unless explicitly assigned otherwise in a written agreement.

This means that if you want to own the copyrights or patents on something created by an independent contractor, it’s important to include a clause in your contract stating this.

Example: If you hire an independent contractor to develop software, make sure your contract includes a "work-for-hire" provision or an assignment of intellectual property rights to avoid disputes later on.

Another Example: If a freelance photographer takes pictures for your business, those photos belong to the photographer unless your contract states otherwise. To use those images freely, you need to have a written agreement transferring the rights to you.

Legal GPS Pro

Protect your business with our complete legal subscription service, designed by top startup attorneys.

• ✅ Complete Legal Toolkit
• ✅ 100+ Editable Contracts
• ✅ Affordable Legal Guidance
• ✅ Custom Legal Status Report

Learn more

Advantages of Hiring Independent Contractors

1. Efficiency and Expertise

Independent contractors are often hired because they are specialists in their field, meaning they can get started without the need for much training. Since they are paid based on results, there is often an incentive for them to complete work efficiently.

Example: Hiring an experienced web developer as an independent contractor means they can immediately start working on your project without needing to go through the onboarding process that an employee would require.

2. Flexibility

Since contractors work on a project-by-project basis, you can scale your workforce up or down as needed. This is particularly helpful for seasonal work or fluctuating demands.

Example: A florist may hire additional independent contractors during Valentine's Day or other holidays when demand is high but doesn’t need to keep those extra workers year-round.

Another Example: A retail store might hire independent contractors for inventory counting at the end of the fiscal year. Once the task is completed, the relationship ends without any obligation for continued employment.

3. Cost Savings

By hiring independent contractors, you avoid the costs associated with employment benefits like health insurance, paid leave, and retirement contributions.

Example: For a business that only needs graphic design services occasionally, hiring a contractor can be more cost-effective than employing a full-time designer, as you only pay for the work done.

Disadvantages of Hiring Independent Contractors

1. Limited Control

You do not have the same level of control over an independent contractor as you do an employee. This means you cannot micromanage or require them to work in a certain way, only specifying the desired end result.

Example: If you hire a marketing consultant, you can set goals and timelines, but you cannot dictate how they should conduct their research or implement their strategies.

2. Lack of Loyalty

An independent contractor’s loyalty often ends with the contract. Unlike employees, who may be more invested in the company’s long-term success, independent contractors have other clients and priorities.

Example: A contractor providing IT support may have multiple clients, and their availability could be limited if they have commitments elsewhere. Unlike an employee, they are not obliged to prioritize your business.

3. Risk of Misclassification

Misclassifying an employee as an independent contractor can lead to significant penalties. If you wrongly classify an employee, you may owe back taxes, unpaid benefits, and even fines. This is why understanding the proper classification is crucial.

Example: If you hire someone as a contractor but treat them like an employee—setting their hours, controlling their work process, and providing benefits—the IRS or Department of Labor could reclassify them as an employee. This could result in back taxes and penalties.

Additional Considerations for Hiring Independent Contractors

Tax Obligations

When hiring employees, employers are responsible for withholding federal income tax, Social Security, and Medicare taxes from their wages. They must also pay a portion of Social Security and Medicare taxes, as well as unemployment taxes.

Independent contractors, however, are responsible for paying their own income taxes and self-employment taxes. This reduces the tax burden on the employer but requires clear communication to ensure contractors understand their obligations.

Example: If you pay an independent contractor more than $600 in a year, you must provide them with a Form 1099-NEC to report their earnings to the IRS.

Benefits and Perks

Employees are typically eligible for benefits like health insurance, retirement plans, paid time off, and bonuses. These benefits are often costly for employers but help attract and retain talent.

Independent contractors do not receive these benefits. While this means lower costs for the business, it may also limit your ability to attract top talent who prefer the security of employee benefits.

Example: A software engineer may prefer a full-time job with benefits over a contractor position without health insurance or paid leave.

Intellectual Property and Confidentiality

To avoid disputes over ownership, it is important to include clear terms in your contract regarding intellectual property (IP) and confidentiality. Independent contractors may have access to sensitive information, and without proper agreements, they could use that information for other clients.

Example: When hiring a contractor to develop a new product prototype, include a confidentiality agreement to protect your business secrets. Also, ensure the contract clearly states that any IP created during the project is owned by your company.

Termination and Contract Length

The terms for ending a working relationship are different for employees and contractors. Employees may have certain rights under employment laws, including notice periods and protection from wrongful termination. Employers must adhere to these requirements when ending an employment relationship.

Independent contractors, however, operate under the terms of their contract. Terminating a contractor before the project is completed could be considered a breach of contract unless otherwise specified in the agreement.

Example: If you hire a contractor to complete a project by a certain date, and you decide to end the relationship early without cause, you may still be liable to pay them for the work they’ve completed or for damages resulting from the early termination.

Pros and Cons Summary

Pros of Hiring Independent Contractors

• Efficiency: Contractors are experts and can start immediately.

• Flexibility: Hire contractors as needed without long-term commitments.

• Cost Savings: Avoid employee benefits and payroll taxes.

Cons of Hiring Independent Contractors

• Limited Control: You cannot dictate how contractors perform their work.

• Lack of Loyalty: Contractors have other clients and limited attachment to your company.

• Risk of Misclassification: Misclassifying contractors can lead to serious financial penalties.

Conclusion

Hiring independent contractors can provide flexibility, cost savings, and access to specialized skills. However, it’s essential to understand the differences in control, liability, tax obligations, and employment laws to ensure you’re making the right decision for your business’s needs. Careful consideration and clear contracts are key to avoiding the risks associated with misclassification and ensuring a successful relationship with your independent contractors.

Do I need a business lawyer?

The biggest question now is, "Do I need a business lawyer?” For most businesses and in most cases, you don't need a lawyer to start your business. Instead, many business owners rely on Legal GPS Pro to help with legal issues.

Legal GPS Pro is your All-In-One Legal Toolkit for Businesses. Developed by top startup attorneys, Pro gives you access to 100+ expertly crafted templates including operating agreements, NDAs, and service agreements, and an interactive platform. All designed to protect your company and set it up for lasting success.

Legal GPS Pro

Protect your business with our complete legal subscription service, designed by top startup attorneys.

• ✅ Complete Legal Toolkit
• ✅ 100+ Editable Contracts
• ✅ Affordable Legal Guidance
• ✅ Custom Legal Status Report

Learn more