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Hiring Employees vs. Contractors: Which is Better?

By Jonathan Horton

Table of Contents



Most small business owners will eventually face an age-old question: what are the benefits of hiring employees vs contractors? Each comes with its own set of advantages and disadvantages, IRS classifications, and more. 

In this article, we’re going to clarify this issue for you by addressing

  • How employees differ from contractors
  • Classification differences between employees and contractors, 
  • And, the pros and cons of each 

Definitions: Employees and Contractors

Employees and contractors function differently within a company. Here are some general guidelines on what an employee looks like vs a contractor. Of course, there are exceptions to each of these definitions. If you’re unsure about whether to classify an employee or contractor, speak to a tax professional to avoid any potential penalties. 

Employees

Employees generally work full-time. However, this isn’t the key defining factor here. Plenty of small businesses hire part-time employees. We certainly do. Employees also generally receive benefits like health insurance and paid time off. Employees also generally perform multiple tasks for a company. 

The most significant defining factor of an employee vs a contractor is an employee works as a long-term hire (ideally). And as such, typically undergoes an extensive onboarding process and then receives further training and growth opportunities during their tenure at the company. 

Contractor

Unlike an employee, a contractor operates as a separate entity from your company under their own contracting business. Rather than a long-term hire, a contractor is typically brought in for their specialized knowledge that applies to one-off projects. 

A contractor usually receives the limited training they need for individual projects. And rather than working for your company alone, they typically have contractual relationships with multiple companies at the same time. 

Proper Classification as an Employee vs Contractor

To determine whether you should classify a work as an employee vs a contractor, Business News Daily recommends asking yourself the following questions: 

    1. When, where, and how is the work done? Does this person have the flexibility to work whenever they want – setting their own work schedule? Do they work onsite or remotely? And do they use their own tools (like a laptop) or are they company-provided? 
    2. Is company training required? Employees generally undergo much more extensive training than contractors. 
    3. Ongoing work or one-off projects? Ongoing work typically signals an employee while one-off projects can signal a contractor.
    4. How are they paid? If they receive regular compensation on an hourly, weekly, salary, etc. basis, they may require an employee classification. Alternatively, if they’re paid by the project, they may require a contractor classification. 
    5. Do you cover their travel expenses? Employees generally get reimbursed for travel expenses, while a contractor covers their own. 

Employee vs Contractor Taxation

It’s important to classify workers correctly as the classification affects how you and they pay taxes. Employees receive a W-2 form, and their employer pays the appropriate state and federal income tax, social security, and Medicare taxes on their behalf. Contractors receive a W-9 form and/or a 1099 form recording their compensation. Contractors report their own federal and state income taxes, social security, and Medicare taxes. 

For more information, check out this helpful article from The Balance for more information on employee vs contractor taxation. 

Potential Implications of Misclassification 

If you misclassify an employee as a contractor, you may be issued fines and penalties by the IRS as well as be required to pay back taxes – depending on the number of W-2s that should have been filed. You may also be required to pay an employee overtime pay. And in some extreme cases, you may be subject to criminal penalties. The severity of the penalty for misclassification depends on whether the misclassification was intentional or not. 

From a non-IRS perspective, a worker misclassification could also lead to disputes over who owns the work. For an employee, the business owns the work. But work done by an independent contractor usually must be contractually signed over. 

Pros and Cons of Hiring an Employee vs Contractor

Employees and contractors come with their own mix of advantages and disadvantages. For many businesses, a mix of the two creates the best hiring solution as each serves different needs. 

Employee Advantages

Because employees work with a company long-term, they receive extensive training that immerses them in the company culture and mission. And that immersion into culture and mission often translates into their work and the length of their tenure with the company. 

Hiring employees also gives you a consistent team. You know who you’re working with for specific projects and goals. And you can control the employee workload, the pace at which projects are completed, and the scheduling of hours. 

Employee Disadvantages

The biggest disadvantage to employees is they’re expensive, especially if you have a high employee turnover rate. Employees are expensive to hire and expensive to train. And that doesn’t include the benefits, bonuses, and more that they receive. 

Contractor Advantages

Small businesses typically hire contractors because they need a specialized skill set – something an employee may not have or may not have the time to develop. Their specialization makes them a good complement to employees. And because they don’t require benefits, insurance, and extensive training, they are generally less long-term expensive. 

Contractor Disadvantages

Because a contractor works for a variety of companies, their loyalty to and investment in your brand is limited compared to an employee. And their minimal onboarding may also affect their knowledge of your brand and products, which can in turn affect project quality.  A contractor can also be inconsistently available since they usually work with multiple companies at the same time. 

Sidebar: This is why you should thoroughly vet a potential contractor by reading reviews, examining portfolios, talking with previous clients, etc. Also, don’t go cheap. You get what you pay for.

Work with Ingenium! 

Do you have questions about classifying a worker as an employee vs contractor? Give us a call! Our HR professionals can help you determine the correct classification for your business. Additionally, if you need to hire a specialized contractor for finance, HR/admin, or marketing needs, our experts are ready to help your business succeed. 

Let’s Talk!