How To Manage Employees vs. Independent Contractors

There have been dramatic shifts in how we work over the past few years, and today, things like WFH (work from home), remote jobs, and freelancing are incredibly common. While employees desire these changes, they’re even more beneficial for employers for various reasons, such as expanded applicant pools, more content employees, and access to world-class talent on demand. But when bringing on different types of workers, organizations need to be prepared to manage them, and they need to be well-versed in the differences between employees versus independent contractors, including the tax and financial implications. 

Keep reading for all that you need to know.

What’s the Difference Between an Independent Contractor and an Employee?

The use of independent workers is on the rise, and in the US alone, that number jumped from 12.9 million in 2017 to 23.9 million in 2021. And while there are many different ways to work with independent workers, many organizations categorize them as independent contractors, which has an official definition within the IRS. This means there are many specific tax obligations to keep in mind regarding employees versus independent contractors.

The IRS Factors

When it comes to the IRS, here are factors to remember. They’ll be vital in helping you manage independent contractors.

Performance

When it comes to independent contractors, the organization hiring them “has the right to control or direct only the result of the work and not what will be done and how it will be done,” according to the IRS. This means that independent contractors typically have more autonomy over their work than employees.

Equipment

According to the IRS, the payer decides who provides tools, supplies, and equipment. That means that if your organization works with independent contractors, it dictates the terms of the engagement as far as equipment is concerned. According to the IRS, independent contractors typically have a “significant investment” in the equipment they use. 

Payment

Payment is one of the aspects of employment that is typically different for employees versus independent contractors. When it comes to independent contractors, business aspects of their job are controlled by the payer, including how the worker is paid and what (if anything) is reimbursed, according to the IRS. Independent contractors are often paid flat fees or hourly.

Benefits

According to the IRS, businesses do not give benefits (such as health insurance, pensions, vacation days, and sick days) to independent contractors. This is another significant difference between employees versus independent contractors.

Term and Termination

When hiring employees versus independent contractors, the IRS states that if the expectation upon hiring is that “the relationship will continue indefinitely,” the hire is typically considered an employee. The opposite usually means that if a person is hired for a short-term arrangement, they’re considered an independent contractor. 

How to Manage Employees

When it comes to managing employees versus independent contractors, there are many differences. Let’s start with employees. 

Because these relationships are fairly permanent, certain protocols and practices must be kept in mind. 

Principles to Remember When Managing Employees

• DO remember that your employees expect permanent employment, and relationships should be managed with the long-term future in mind.
• DO keep in mind employee considerations such as benefits, health insurance, perks (such as gym reimbursements), and equipment needs. 
• DO acknowledge that your organization will typically need to withhold income tax, social security, and Medicare from employee wages.
• DON’T forget that employers tend to have more control over employee performance than they do with independent contractors.
• DON’T fail to understand the tax obligations that come with hiring employees.

How to Manage Independent Contractors

Managing employees is one thing, but managing independent contractors is entirely different. Because they’re not full-time employees, there are differences in communication needs, work styles, and accounting and taxation needs. 

Let’s go over the principles to remember, along with dos and don’ts.

Principles to Remember When Managing Contractors

• DO keep in mind that independent contractors have more control over how they do their work than employees.
• DO remember that independent contractors might have unique communication needs since they’re not as “in the loop” when it comes to your organization.
• DO acknowledge that independent contractors don’t have the same requirements for benefits and that the terms of work engagements are typically temporary.
• DON’T forget that independent contractors are generally responsible for their own equipment.
• DON’T fail to recognize that paying independent contractors is typically a different process than employees, and it might require an invoicing procedure, for example. 
• DON’T neglect the tax obligations that come with working with independent contractors.

Your Tax Obligations

Ah, tax obligations. Every business owner has them, and it’s important to understand the distinctions in tax obligations when it comes to employees versus independent contractors. We’ll break it down for you.

Employees

When it comes to employees, the IRS has several critical tax obligations for employers. Firstly, “employers generally must withhold federal income tax from employees’ wages,” and employers are typically responsible for figuring out how much tax to withhold. Employers generally “must withhold social security and Medicare taxes” from wages and pay part of the tax themselves. 

Independent Contractors

When it comes to independent contractors, employers generally have fewer tax obligations than they do with employees. Typically, employers do not withhold federal income taxes from their independent contractors’ wages. Instead, the independent contractor is subject to paying a self-employment tax on their income. 

Intellectual Property Concerns

Another critical thing to understand when it comes to employees versus independent contractors is the concerns and terms regarding intellectual property or things that are the “work or invention” where copyright or patent could apply. 

Let’s go over how they work for employees and contractors.

Employees

When it comes to employees, employers are typically the owners of the intellectual property that they create. According to experts, “if a work is created by an employee in the course of his or her employment, the employer owns the copyright.” 

Independent Contractors

When it comes to independent contractors, intellectual property is far more nuanced. Generally, if the work is “made for hire” or “created by an employee within the scope of his or her employment,” then the hiring organization typically owns the work. 

This can create intellectual property concerns, especially regarding work the independent contractor creates outside of the terms of employment. Organizations might include supplemental clauses in their contracts to protect their intellectual property further. 

Other Considerations When Working With a Contractor or Employee

Aside from IRS obligations, general principles, and intellectual property, there are several other tax obligations to keep in mind. They are listed below.

Written Agreements

Written agreements are crucial for both employees and independent contractors but might be even more critical for independent contractors. These agreements can outline the scope of work expected, the time frame to complete said work, and other aspects of the engagement. Adding these to written agreements (such as contracts) can be crucial for guaranteeing the independent contractor is contractually responsible for them. 

Confidentiality

Confidentiality is another consideration that is typically important to both employees and independent contractors. While most employee contracts tend to have a confidentiality clause, employers often choose to include a similar clause if they engage with an independent contractor to ensure they comply. 

Non-Solicitation

Non-solicitation typically refers to an employee or contractor engaging with (or attempting to engage with) a company’s customers independently. This agreement is usually necessary for both employees and independent contractors and can help ensure that independent contractors don’t attempt to “poach” an organization’s customers after their engagement.

Non-Compete

While employees typically have non-compete clauses in their contracts (which generally means they can’t work at competitor organizations during their employment and for some time after), these clauses aren’t always included when it comes to independent contractors. Independent contractors work for multiple organizations simultaneously, and employers tend to have less control over where they work.

Understanding the Best Option for Your Company

Regarding employees versus independent contractors, both options can be excellent for your company, especially if you’re running a startup or another fast-growing business. Deciding which type of hire to go with depends on your individual needs and capabilities and requires organizations to understand the differences between the two (especially when it comes to tax and accounting needs). 

In general, when it comes to accounting solutions for startups, there is a lot that organizations need to get right, including taxes, accounting, HR needs, and payroll. But by understanding the differences in hires and your accounting and financial needs, startup leaders and founders can empower their organizations to grow by making the best decisions possible for the future.