The difference between an independent contractor vs employee affects taxes, benefits and legal duties, and getting it wrong can be expensive.
Independent contractor vs employee: the basic idea
An employee works under your direction and generally receives a paycheck with taxes withheld. An independent contractor runs their own business, controls how the work is done and invoices you. This article is general information, not legal or tax advice, and the tests used by agencies are detailed, so confirm your situation with a professional.
- Employees work under your direction
- Contractors run their own business
- Rules come from several agencies
How agencies look at independent contractor vs employee
Agencies look at the whole relationship, not just the label you choose. The IRS commonly looks at behavioral control, financial control and the type of relationship, and the U.S. Department of Labor applies its own tests for wage rules. A signed contract calling someone a contractor does not settle it on its own. Check the IRS small business and self-employed tax center for current guidance.
- Behavioral control: who directs the work
- Financial control: who bears costs and risk
- The nature of the relationship
Why independent contractor vs employee classification matters
Employers withhold and pay payroll taxes for employees, and may owe benefits, overtime and insurance. Contractors handle their own taxes and usually supply their own tools. Treating an employee as a contractor can lead to back taxes, penalties and claims. Our guide on business insurance basics mentions workers’ compensation, and our estimated taxes guide explains what contractors usually pay on their own.
- Payroll taxes and withholding
- Benefits, overtime and insurance
- Penalties for misclassification
If you are the contractor
Working as a contractor gives flexibility but also responsibility. You usually pay self-employment tax, set aside money for taxes, track expenses and find your own clients. Our guide on bookkeeping basics helps, and our guide on legal basics for starting a business covers registrations to check.
- Set aside money for taxes
- Track expenses and invoices
- Check registrations and insurance
If you are hiring
Before you hire, ask whether you control how, when and where the work is done. If you do, the person may be an employee. When in doubt, ask an accountant or employment attorney before you start. Written agreements help but do not replace the facts of the relationship.
- Ask who controls the work
- Use written agreements
- Get advice when unsure
Where to get help
The IRS and Department of Labor publish classification guidance, and your local SBDC or SCORE can help you find a qualified adviser. Understanding independent contractor vs employee rules before you hire or sign saves trouble later.
- IRS and Department of Labor guidance
- Free advisors at SBDC and SCORE
- A professional for your specific facts
Related reading on independent contractor vs employee
- Business Insurance Basics: Coverage to Ask About
- Estimated Taxes for Small Business Owners Explained
- Bookkeeping Basics for Small Business Owners
- Legal Basics for Starting a Business: A Checklist
- How to Open a Business Bank Account
- Business Licenses and Permits: A Starter Checklist
- IRS small business and self-employed tax center
- U.S. Department of Labor on worker classification
- America’s SBDC small business advising
- SCORE free business mentoring
