Temporary employees and contract workers help small businesses cover short-term needs, but they aren’t the same. A temporary employee is hired by your company or through a staffing agency. Meanwhile, a contract worker (independent contractor) operates as a separate business, such as a sole proprietor or limited liability company (LLC).
Understanding these distinctions is critical, since misclassification can lead to penalties, lawsuits, or surprise tax bills. This guide explains the key differences between temporary employees and contract workers, when to hire each, and how to stay compliant.
Temporary vs. contract employee: Key differences at a glance
- Independent contractors are self-employed. They usually take on specific projects, control how the work is done, and pay their own taxes.
- Temporary workers are employees of your business or a staffing agency. They follow your schedule, training, and supervision. They can be part time, full time, or seasonal.
- A key difference between temporary employees and contractors is that workplace protections cover temps, not contractors.
- The legal requirements for hiring employees differ from those for hiring contractors. Temps require I-9 verification and receive a W-2, while contractors provide a W-9, and you issue a 1099 if you pay them $600 or more during the year.
Independent contractor and temporary employee definitions
Small businesses often rely on a contingent workforce of temporary employees and independent contractors. Both may work for a short time and occasionally do similar tasks, but they are defined and treated differently under tax and labor laws.
A temporary employee is a worker hired to meet short-term needs, like covering shifts for an employee on leave or during a busy season. They’re part of your workforce and are under your supervision. As the employer, you set the schedule and provide training and tools.
An independent contractor is a worker hired to complete a project or provide special services that are not part of your core business functions. They control how and when they work. Even though contractors may participate in meetings or workplace functions, they’re not directly under your supervision.
However, hybrid working trends can blur the distinction between temporary and contract employees. The IRS and the U.S. Department of Labor (DOL) provide guidance to help small businesses classify employees and contractors correctly.
Legal considerations for contract workers and temporary staffing
The IRS uses a general rule to determine the difference between employees and independent contractors. If an employer-employee relationship exists in any form, the person doing the work is an employee. It defines this relationship as the employer having the “legal right to control the details of how the services are performed.” The IRS considers facts from three common law categories (behavioral, financial, and relationship type) for evidence about the degree of control and independence.
If you’re unsure how to classify employees or contractors, you can file Form SS-8 to request a determination of worker status. Employers, employees, and freelancers can file this form to ensure requirements are met for federal employment taxes and income tax withholding.
The DOL’s Wage and Hour Division (WHD) oversees labor laws like the Fair Labor Standards Act (FLSA). It uses economic reality factors to determine if workers are covered under the FLSA. The goal of the test is to “decide if the worker is economically dependent on the employer for work or is instead in business for themself.”
In addition to common law and economic reality factors, state laws, such as the ABC test in California, may affect the definition of employees and contractors. Ongoing legal challenges also question the classification of gig workers and may influence enforcement.
Tax and benefits implications
Classifying a worker as a temporary employee or contractor affects taxes and benefits. It’s important to understand the difference between W-2 versus 1099-NEC forms, because employees require tax withholding and employer payroll contributions, while independent contractors pay their own taxes. Employment taxes include Medicare and Social Security via the Federal Insurance Contributions Act (FICA) and the Federal Unemployment Tax Act.
Here’s how contractor versus employee taxes differ:
- Temporary employee: You must withhold income and payroll tax and pay employer FICA and unemployment taxes. At the end of the year, you issue a W-2.
- Contractor: You don’t withhold payroll taxes or pay employer taxes. If you pay the contractor $600 or more (the IRS filing threshold), you issue a 1099-NEC at the end of the year.
In addition to tax form differences, temporary W-2 workers may qualify for benefits if they meet your retirement plan’s rules. According to the Employee Retirement Income Security Act of 1974, or ERISA, plan rules vary, but “part-time employees may be eligible if they work at least 1,000 hours per year.” Independent contractors are generally not eligible for benefits.
Misclassification penalties
Misclassifying a worker as an independent contractor when they should be a temporary employee can be an expensive mistake. The IRS, DOL, and sometimes your state impose misclassification penalties for small businesses.
Here’s what each agency could require from your company if workers are misclassified:
- IRS (tax penalties): The IRS may request back employment taxes under tax code Section 3509. This is 1.5% of wages plus your share (20%) of FICA. The IRS doubles the penalties to 3% of wages and 40% for FICA if the business didn’t file information forms (1099-NEC) for the misclassified contractor.
- DOL (wages and fines): The DOL can require you to pay back for minimum wage or overtime and may add civil penalties if it determines that you repeatedly or willfully misclassify employees. The DOL adjusts civil money penalties annually.
- State agencies: States may add penalties for unpaid unemployment insurance, workers’ compensation premiums, and state payroll taxes.
The DOL’s May 2025 field assistance bulletin announced that it was using an older, more flexible standard for enforcement purposes while the government reviews the FLSA's 2024 Employee or Independent Contractor Classification rule. However, private lawsuits can still apply the 2024 rule, and states can impose stricter standards.
Documentation for hiring temporary employees and contractors
Small businesses should clearly and consistently document how they determined worker status in human resources systems, on contracts, and in hiring and recruiting content. These steps improve recordkeeping and transparency while providing evidence in the event of a compliance audit. For entry-level roles meant to build future talent, consider developing an internship program instead of relying on short-term hires.
When listing a position on job posting sites for small businesses, state whether it’s a temporary W-2 employee position or a 1099 independent contractor role. Categorizing the post correctly helps you attract suitable candidates and avoid misleading workers, which could raise red flags in disputes or audits. Likewise, an applicant tracking system integrated with payroll or HR software can make it easier to filter candidates for contract versus employee roles and route them into the correct onboarding workflows.
How to decide which worker type to hire
To decide if you need a temporary employee or contractor, consider the scope of work and the amount of control you have over the person’s schedule, tools, and methods.
Use this contractor versus employee checklist to decide which worker type to hire:
- Is the type of work core to your business? The tasks workers perform affect how you classify them. Seasonal workers who build widgets at a widget-building factory are temporary employees. But outsourced accounting tasks or marketing strategies are specialized activities that an independent contractor can handle.
- Who controls how work is done? If you tell the worker how and when to do the job, they will likely be employees under IRS common law rules and the FLSA’s economic reality test. When you set the outcome or deadline and the worker chooses their own methods and schedule, they fit into the independent contractor category.
- What’s the expected duration and flow of work? Jobs that are short term but part of your normal operations, like seasonal retail help or covering an employee on leave, are W-2 employees. However, work that is project-based or sporadic indicates a contract worker status.
- Does the worker need employer-provided tools and accounts? When companies give workers software logins, equipment, and workspaces to do tasks, they usually count as employees. If someone uses their tools and software to deliver a final result, they will likely be a contractor.
- Do you have onboarding, payroll, and training capacity? If your business has payroll, HR processes, and time to train, a temporary W-2 employee may be the right fit. Alternatively, you can rely on a staffing agency to provide a temp employee or hire an independent contractor with the expertise to work independently.
Examples of when to hire a temp vs. a contractor
A retailer or manufacturer may need both types of workers. Staffing firms can provide seasonal staff, or you can hire temporary employees directly. Either way, the temp performs work tied to your core business functions, such as running cash registers, stocking shelves during the holidays, or producing goods. Temporary employees usually work on a set schedule and receive direct supervision during their shifts.
Independent contractors are best for noncore business tasks like marketing, accounting, or maintenance. If a pipe bursts, your computer system is hacked, or your office needs cleaning, a contractor can step in to solve the problem. Although you can manage these functions in-house, outsourcing to a third party may be more beneficial.
Sometimes, the line is less obvious. For example, you could hire a virtual assistant as either a contractor or an employee. To decide, consider who sets their hours and provides their tools. If you’re still unsure, review IRS and DOL guidelines, contact your state labor office, or speak with a tax adviser. Lastly, in some instances, especially for leadership or specialized part-time roles, small businesses may want to explore fractional hiring as a flexible alternative to choosing between contractors or temporary employees.
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