What is the difference between an independent contractor and an employee?

Ever wondered why contractors are cheaper than employees tax-wise? Been thinking about why companies are not allowed to turn every employee into a contractor and thus save on tax? Well, we at EasyStaff think about questions like this all the time. Here is what we know about the difference between an employee and a contractor and why it is important to legally classify your workers correctly to avoid penalties.

An employee is a hired worker. They are hired to do a specific job, and a contract is usually long-term. By law, employees are controlled, i.e. it is their employer who oversees how and when employees work and how much they are paid. The reason why employees are dependent on employers and are controlled by them is because it is employers who take on all the financial risks. Unlike in any other case, an employee works for a regular pay and some benefits offered by the employer, either voluntarily or by law.

The major document that regulates the relationship between employee and employer is an employment contract, although there are variations, such as an offer letter or a verbal agreement. If there is a labor union in a workplace, then it is the labor union that negotiates compensation, benefits, working hours, sick leaves and vacations. The organization does that collectively, for all the employees at once.

Money-wise, there is a fixed pay. They are paid for their experience, knowledge and contribution to the employer’s revenue. Employment may be full-time, part-time or a temporary job assignment. Employees may be paid on top of a regular pay for overtime. An If an employee is classified as non-exempt, then the employer needs to set up a tracking system to take into account every hour that an employee working to account for overtime pay.

An employee is paid for a specific job that is defined in a job description. The expected result is described with KPIs that are in turn defined by the HR department of the company. Structure-wise, an employee is a part of a division or a department, like operations or finance. They report to their supervisor, and take directions from them. Employees have a place and all supplies they need for work provided by their employer. In companies where there is care for employees and planning for future, there is a feedback system in place, like 360 reviews, that heps teams grow and exchange feedback across the staff.

A self-employed individual who works on a contract basis is a contractor, also known as a contract worker, an independent contractor or a freelancer. Normally, to work with companies, a self-employed individual needs to have some legal standing, such as a sole proprietorship, a limited liability partnership or a limited liability company. As a rule, contractors take on several projects, as they are able to work with more than one client at a time.

Contractors are easier to manage for a number of reasons. First, contractors are responsible for the result (while employees don’t carry financial risks for the enterprise). That’s why they expect and need far less control than full-time staff workers. Second, contractors receive an agreed-upon wage and pay tax themselves — namely, federal income tax and self-employed tax. Social benefits, such as health insurance or deductions towards pension, are also on the self-employed.

Individual contractors are freelancers, essentially. Thanks to no taxation requirements, they are welcome for hire by some companies where there is a one-off (or at least irregular) task that is too expensive to create an entire in-house team for. So the priority with contractors is their niche expertise. Where an employee needs to be screened and hired, a contractor can start working on the task right away.

Lastly, flexibility is an important trait that sets contractors apart from regular hired workers. Normally, contractors don’t need any additional training to start working on a project. Their overall contact with the client team normally runs through a single point of contact, like a manager or a project lead.

In every country there are special administrative bodies that monitor how companies pay taxes. Any payment that is made by the company is subject to tax, except payrolls. When examining a company’s financial activity, the government services check if payrolls are indeed made to fully and legally hired employees. If a payment is a payroll, there also should be information provided concerning social and medical insurance payments made for every salary payout for every employee. If there is a salary payout not followed by necessary insurance payments, then there may be fines for not providing for an employee.

To avoid such situations, companies should guide themselves with the following questions:

• When, where and how is the work done?
• Employee. At the employer’s premises, with their resources and tools. There is a schedule to stick to and a regular reporting schedule.

Independent contractor. At their premises, with their own tools and resources. There is no schedule to work on, but there is a deadline for when a task needs to be done.

• Does the worker work full-time?

Employee. They may work full-time or part-time, but it is a rigid schedule that matters. The end result of employed labor is a particular function performed by the worker.
Independent contractor. They work on any schedule that suits them. However, there is little control over their activity and there are deadlines to navigate their work. The end result is a tangible product, rather than a function.

• Does the worker get paid periodically (monthly, weekly, hourly) or in full after a project is complete?

Employee. Hired workers are paid regularly.
Independent contractors. As a rule, they are paid in full once a project is complete. However, there may be some payment upfront, depending on the contractor’s conditions.

• What document regulates the relationship between the company and the worker?

Employee. With a hired worker, it is a labor contract. This document regulates the relationship and it is meant to be long-term. In a labor contract, the parties are not independent, as an employee depends on their employer.
Individual contractor. With a freelancer, it is a service agreement. In a service agreement, the parties are independent, meaning contractors pay their own taxes and companies don’t owe them anything but the agreed-upon wage.

It is the controlling tax agencies who decide that a business has been unlawfully paying a salary to its employee without additional payments towards the employee’s insurance. If such an organization finds out, they fine the company and force it to pay back taxes and penalties.

To avoid misclassification, companies need to be very careful with the documents that prove the true nature of a relationship.

For contractors, it is a service agreement that works best. The agreement establishes equality of the parties and mentions what work needs to be done and by when. In the agreement, there should be a clearly stated description of what exactly needs to be done as well as a proper result description. Payment-wise, there should be a specific sum mentioned.

For employees, it is a labor contract that fits. The contract explains that the employer is going to pay for a function fulfilled and how much that payment will be. Unlike in the case with the contractor where there is a full sum to be paid at once, in the labor contract there is a salary mentioned, either a yearly and a monthly sum, and a payroll schedule.

While managing contractors and employees is already difficult even at home, a business that ventures out to be an international player may encounter still more difficulties with managing foreign contractors.

That’s why relying on a freelancer management platform to facilitate payments and generate fully compliant documents is a perfect option. This is where EasyStaff steps in!

To send payment to your freelancers hustle-free, you need to create an account and add money to it. After that, create a task and assign a freelancer to it. Once a task is complete, you can send money in just one click. After payment is done, closing documents are generated automatically in your account. EasyStaff charges a commission, and the baseline is 39 euro or 4% per payment. Fortunately, there is a choice of tariffs to match any clients' needs.

The reason why EasyStaff is able to send any payments to any country is that it is a European legal entity. This means that for clients, no matter what freelancer they are paying, on paper they are working with a single B2B agent managed through a B2B service agreement.

Reaching out to foreign workforce and paying overseas contractors has never been this easy. Couple of clicks, and your task is on its way to be completed by the desired contractor with EasyStaff.