Contract Employees vs. Full-time Workers

Small Business

Contract Employees vs. Full-time Workers

Updated on October 31, 2019

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The primary distinction between contract employees and full-time workers revolves around differences in the employer-employee relationship and tax liabilities. Typically, a contracted worker has more independence over how they complete their work and is responsible for their own taxes, while a full-time employee works under the direction and supervision of an employer who reports their taxes. For a small business, working with contracted and full-time employees can have advantages for both the employer as well as employees.

What are the differences between contract employees and full-time workers?

While there is no exact definition of either contracted or full-time workers, the main differences between contract employees and full-time employees are the degree of the employer’s control over their work and the manner in which their taxes are reported to the IRS.

Here is a general overview of how to understand the major difference between contracted workers and full-time employees:

  • An independently contracted worker performs their services separately from the business that contracts them. The contract employee also pays taxes on the money they are paid by their client, the business.
  • A full-time worker functions as part of a business, with their employer reporting their taxes and providing them with direct supervision over the work they perform.

While contracted employees often tend to be cheaper for a business (since employers do not need to offer them fringe benefits such as health insurance or pay payroll taxes for them), there have been issues in the past where businesses have misclassified full-time employees as contracted employees, resulting in significant tax penalties and fees.

To help small business owners properly classify employees, the IRS has guidelines which provide assistance in defining different types of workers. Employers can also consult this checklist to help them differentiate full-time employees and independent contractors.

Understanding the distinctions between contracted and full-time employees is crucial for a small business seeking to expand or enhance its workforce. Continue reading to find out more specific requirements associated with both types of workers.

Source: U.S. Small Business Administration (SBA)

What are contract workers?

A contract worker, also known as an independent contractor or 1099 employee (based on the 1099 tax form they receive), is an individual who enters into a contractual agreement with a business in order to provide a service in exchange for a fee.

To be considered a contracted employee, a worker must generally meet the following requirements:

  • Be responsible for paying their own taxes on the payment they receive from the business
  • Use their own equipment and supplies in order to complete their contracted work
  • Provide an invoice upon the completion of their work, as per their contractual agreement

Contracted workers are not technically “employees” since they provide services on a short-term or individual project basis. Also, unlike full-time employees, contract workers do not have to be offered employment benefits by the businesses that hire them.

What are full-time employees?

Full-time employees, also known as common-law employees or W-2 employees (based on the W-2 tax form they receive), are supervised by their employer, who directs and controls their work throughout a long-term relationship. The employer must pay payroll taxes for each of their full-time employees, as well as provide them with certain legally required benefits.

According to the IRS, there are three factors for businesses to consider when classifying workers as either full-time employees or contracted workers:

  1. Control over behavior – Does the employer have the right to control what the worker does and how the worker completes his or her job (i.e. the scheduling or process of the work)?
  2. Control over finances – Does the employer control how the worker is paid? Does the employer provide supplies, reimburse expenses, or pay payroll, Social Security, and Medicare taxes?
  3. Type of employer relationship – Does the employer offer employee-type benefits? Is the relationship between the employer and worker ongoing or a key part of the business?

If most of these factors apply to the workers hired by a small business, then they would probably be considered full-time employees by the IRS.

Contract employees vs. full-time workers: what are the benefits of each?

For a small business, there are advantages to working with both contracted workers and full-time employees. Here are several factors to consider when comparing these two types of workers.

  • Costs – Due to differences in tax liabilities and benefit obligations, contract workers (who often charge higher flat fees or hourly rates than employees) tend to cost less overall for a small business than full-time employees. However, small business owners should make sure they do not end up misclassifying workers, as they could end up facing tax penalties as a result.
  • Project Scope – Contract workers may be a better choice for short-term projects which require outside expertise, such as technical consultations, seasonal assistance, or administrative services. For ongoing work that requires supervision, involves building relationships, or plays an important role for the business, hiring full-time employees may be the right way to go.
  • Loyalty – Due to the short-term nature of contract projects, a contracted worker might stop working with a business if another company offers to pay them more, or be less accessible if they have multiple clients. Full-time employees may be more likely to remain loyal and committed to their employer in the long-term, especially if they are offered desirable benefits.

Ultimately, both contract workers and full-time employees can serve as good choices to fulfill the different projects and needs of a small business.

This article is for general information and may not be updated after publication. Consult your own tax, accounting, or legal advisor instead of relying on this article as tax, accounting, or legal advice.

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