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Contract workers differ from internal employees in many ways, and those differences are important to know if you're thinking about what kind of worker to hire. — Getty Images/seb_ra

Contract workers are becoming more common. According to a 2021 survey from Upwork, contractors make up approximately 36% of the workforce.

A contract worker is also known as a contractor, independent contractor, contract employee, freelancer or self-employed worker. Hiring a contractor comes with benefits and also potential drawbacks. Here are answers to common questions about contract workers, including key comparisons between contract employees and internal employees.

What’s the difference between a contract worker and an employee?

One key difference between contractors and employees is how they are paid. Employees are on the company’s payroll, which means they receive wages or salary on a set schedule and the employer withholds federal income tax, Social Security tax and Medicare tax. Independent contractors may be compensated per hour, per project or via flat fee, often paid after the work is completed. The contractor is responsible for paying their own taxes, including self-employment tax.

Internal employees have set workdays and hours and perform labor for your company on an ongoing basis—whereas contractors generally work with your company for a predetermined time frame and set price. A contractor may work for many companies at once, while a full-time employee is typically dedicated to a single company.

Another major difference is the amount of training a worker receives. Oftentimes, contractors receive only information that relates to the project at hand, versus larger onboarding of employees into the company culture and goals.

Why hire a contract worker?

Freelancers can be a cost-effective way to serve temporary needs within your company and fill gaps in specialized skills. Employers can benefit from niche expertise (for example, graphic design, SEO or content writing) on an as-needed basis without the higher cost of a full-time employee.

As experts in their field, self-employed contractors can typically hit the ground running with little downtime. However, the short-term nature of the agreement means they may not always be available when you need them.

[Read more: How to Hire a Freelancer]

Oftentimes, contractors receive only information that relates to the project at hand, versus larger onboarding of employees into the company culture and goals.

What are the employer’s responsibilities when hiring a contract worker?

Most importantly, employers must understand how to correctly classify workers for tax purposes. As the employer, you are responsible for issuing a 1099 tax form to the contract employee in accordance with IRS tax-filing deadlines. When the contractor begins, have them fill out a W-9 form (use W8-BEN for international vendors).

Independent contractors typically don’t receive employee benefits like health insurance, unemployment insurance, PTO and disability insurance. If a contractor works remotely, you do not have to provide office resources like computers, printers or internet service.

[Read more: A Quick Guide to Small Business Employee Health Insurance]

How do you determine if someone is a contract worker?

As far as the IRS is concerned, there’s a fine line between an independent contractor relationship and an employer-employee relationship. If you misclassify an employee as an independent contractor, you could face penalties including back payment of unemployment taxes for the worker(s) in question.

Although a contract may state that a worker is an independent contractor, the IRS officially determines this based on how the parties work together. Major deciding factors include:

  • Nature of the work: If the work performed is considered a key business aspect (and thus if it’s more likely that the business will have the right to direct and control the worker’s activities), it might indicate the worker is an employee.
  • Payment, taxation and benefits: Businesses generally don’t pay benefits, withhold taxes or provide equipment to independent contractors. However, the absence of such benefits does not necessarily mean the worker is an independent contractor.
  • Permanency of the relationship: If you hire a worker with the intention of continuing the relationship indefinitely, it could point to an employer-employee situation.
  • Autonomy: Independent contractors have more control over what they do as well as how and when they work.

If you’re unsure whether someone is an employee or a contract worker, consult an employment law attorney or check directly with the IRS to avoid potential issues.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published January 24, 2022