Employee vs. Contractor: Which Does My Business Need and Why?

Contractors can be a cost-effective way to bring short-term or specialized talent into your organization. However, understanding the risks, costs, and legal implications is crucial. This article will compare Employees and Contractors, highlight the financial and compliance considerations, and explore platforms that help businesses manage Contractor relationships effectively.

Are Employees different from Contractors?

The key difference between an Employee and a Contractor is control. Employee classification is dependent on how the end-state deliverable is defined as well as the methodology & processes used to complete the deliverable. Employees follow company-defined schedules, methods, and deliverables, while Contractors operate independently, using their own processes to achieve a set outcome

An Employee operates within the parameters set by the business, adhering to its preferred timeline and methodology to achieve what is best for the organization. A Contractor retains this control, whereby they are given a prompt and are paid a fee to deliver results using their preferred methodologies. 

Below are some key businesses differences between Employees and Contractors:

If you’re wondering whether your working relationships resemble an Employee or Contractor relationship, refer to the chart above. Ask yourself who controls the how, the when and the where, as well as the conversation around cost of services.

Why does it matter if I treat a Contractor like an Employee?

The answer to this comes down to finances. Governments often use payroll taxes as a primary source of revenue to provide public services and fund social welfare programs. Circumventing these funding sources can negatively impact a jurisdiction’s ability to provide services. 

In the United States, there are three primary cost components that influence the Employee vs. Contractor cost-benefits analysis: (1) FICA & FUTA taxes (2) benefits and (3) cost of services.

• FICA & FUTA taxes: Employees split FICA taxes with their employer (50/50), whereas Contractors must pay the full amount themselves. Additionally, Employees are eligible for unemployment benefits (FUTA-funded), while Contractors are not.
• Benefits: As an Employee, you’re (generally) eligible for company benefits, such as Health Insurance, a company laptop or a cell phone reimbursement. As a Contractor, you are not eligible for Company benefits.
• Cost of Services: As an Employee, you’re paid a salary and are (generally) eligible for Company bonus & incentive programs. As a Contractor, you dictate your fee structure (i.e. you decide when your rates go up) and your payment is usually tied to output on either a per hour or project-based basis.

Note:  Expect Contractors to bake these differences into their rates. 

The above breakdown reflects costs associated with Employees or Contractors in the United States. While every country deploys their own nuanced taxation system, similar to the United States, there are often payroll and / or other related taxes that individuals or businesses are required to pay. Any attempt to avoid paying these taxes is subject to compensatory and punitive damages. It’s important to understand the complete cost of doing business in the country you’re using resources, inclusive of taxes and / or other mandatory payments into public and social welfare programs. 

Helpful hint: When thinking about the cost of your Employees in the United States, the total amounts paid are higher than the face value of a salary. In practice, the total cost of employing a worker in the United States is typically 25% to 35% higher than their base salary when factoring in payroll taxes, benefits, and other employer obligations. See chart below to get a sense of total costs associated with hiring an Employee in other Counties.

Estimated tax burden percentage includes payroll taxes, mandatory retirement contributions, health & social benefit programs, paid leave and other miscellaneous taxes.

The rationale for using Contractor services becomes clearer when you understand the costs. Hiring a project-based or short-term Contractor to accelerate business needs or fill talent gaps can be a great, cost-effective way to influx talent into your organization without the long-term commitments afforded to an Employee.

How Contractors are Commonly Used in Startups?

The use of international contractors is commonplace in many businesses, especially for early-stage tech companies. Hiring contractors often translates to significant cost efficiencies. By engaging talent on a project basis, startups can avoid the overheads associated with full-time employment, preserve cash flow, and remain agile—key factors for thriving in a competitive, fast-paced environment.

Additionally, startups leverage contractors to tap into a global talent pool, accessing specialized skills that might not be readily available locally. This approach allows them to bring in experts from various regions, each offering unique insights and helping compress the hiring cycle, which can help drive progress at a faster rate for the company.

Does Misclassifying Employees Save Money?

At first glance, hiring Contractors seems like a cost-saving advantage. However, misclassifying a worker as a Contractor—when they function more like an Employee—can create significant financial and legal risks.

What if this “Contractor” is becoming business critical so you start to extend “bonus” type payments to avoid losing the resource? What if you’ve provided this “Contractor” with a Company laptop or a company email address? What if you’re requiring this “Contractor” to work weekends and holiday breaks? In these examples, the established Contractor / Business relationship may be shifting to more of an Employee / Employer relationship. If a Contractor relationship changes, the relationship may need to be reclassified at the risk of potential legal and financial consequences. 

As you can see, the Employee / Contractor classification can become quite blurry. Not to mention the perverse incentives - for both Individuals and businesses - to classify resources as Contractors and not Employees. Misclassifying this relationship to purposely reduce costs is not compliant and could come back to haunt you with untimely compensatory or punitive damages that severely hamper cash flow & runway. Uber and Lyft are high profile businesses that have been in the news related to Employee misclassification. In California, a new three-part “ABC” test was introduced to help determine the status of external resources. Under this new law in California, if your resource (1) is free from the control and direction of the business, (2) completes work or projects that are generally the usual course of the business and (3) is engaged in an independently established trade that typically provides similar services to other clients then your resource is a Contractor.

While these resource relationships are often murky, the risk of misclassification is real (albeit infrequently prosecuted). And it can be costly to your business if found liable for misclassification risk. We encourage our Clients to work with Counsel to better understand what resource misclassification is, assess the potential scale of misclassification risk and, ultimately, determine the business appetite for taking on this risk.

‍I’m working with Contractors, how do I minimize my risk?

With the advancement of technology within the Human Resources space, there are now many great options in the market to help manage your Contractor & Employee workforce. 

The path to employing international resources used to be time intensive and costly. Historically, a business pursuing resources in another country was required to set up a local entity (open local accounts, find office space), understand local employment laws (legal fees!) and figure out how to pay resources pursuant to local laws. Today, businesses can use software services that handle this legwork for you. These platforms act as the Employer Of Record (EOR), becoming the worker’s legal employer, managing payroll, benefits, and tax compliance, while the business retains full operational oversight.

Below, find a short list of EOR options to help manage your Contractor needs:

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Summing it all up

Using Contractors - especially International Contractors - can be a great way to infuse talent into your organization in a cost effective manner. Work with Counsel to understand the pros & cons associated with Contractor resources, including the impact of misclassification risk. If hiring Contractors is the right move for your business, assess the systems available for Contractor and / or EOR management to better help reduce risk and streamline management of these resources.