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Employee or Contractor? (in plain terms)

Every business has to have help to succeed, but how do you know what type of help works best? What's the difference between an employee and a contractor? The IRS says "To better determine how to properly classify a worker, consider these three categories Behavioral Control, Financial Control and Relationship of the Parties". You can read more about this at

Whether you choose to have employees or contractors help you can have a lot of financial aspects. It is important to make the right decision from the beginning of each relationship.


Employees are people that you hire directly and are on your payroll. You determine their wages, schedule, sick/vacation time, as well as forms of discipline. You pay them, deduct taxes, and pay employer state and federal taxes. You will also have to pay into unemployment insurance. Some states have other requirements like workers compensation for the employees. You will also know you have an employee, if you have a long term commitment to employ them. Usually there is no time limit on employees and your contract with them is for a complete job and not just 1 project. The employer will need to furnish all items or equipment needed for an employee to complete their job. Some newer businesses may not be able to afford all the expenses of having employees and opt to hire general contractors.


General contractors are paid by tax form 1099 at the end of the year. As the employer, you do not deduct or pay taxes on behalf of contractors. The contractor is required to pay their own taxes directly. General contractors provide their own equipment and also make their own schedule, in essence they work for themselves and are just providing a service for you. There are rules that allow you to make agreements as to scheduling in order to keep providing work to the contractor. One important item is that contractors do not receive any type of unemployment benefits if they are let go from your company. They are also able to work with other companies outside of yours.


It is very important to explain the difference to anyone you decide to hire. Remember the IRS has consequences and classifying an employee as an independent contractor with no reasonable basis for doing so makes employers liable for employment taxes. There may be other financial consequences that will date back to the original date of the business relationship.


If someone you hire as a contractor files for unemployment, they will have the opportunity to prove that you misclassified them and they should be considered an employee. This is not something you want to happen, therefore make sure you know the differences.

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