Independent Contractors vs. Employees: Key Differences Explained

Ever wondered what the differences are between employees and independent contractors? In many respects, there seems to be no difference at all. Freelancers and employees often work side by side at the same company, even doing the same or similar work. However, there are important legal differences between an independent contractor and an employee.

Your job status affects many issues. These include benefits, taxes, and liability. If you’re accepting a job offer to be an independent contractor, you should know some of the key differences.

What Is the Difference Between an Employee and an Independent Contractor?

The difference between an employee and an independent contractor centers on the level of control in the working relationship. An employee is a worker whose job duties, schedule, work methods, and workplace are controlled by an employer, while an independent contractor is a self-employed worker who maintains control over how, when, and where they complete work for their clients. This distinction affects everything from tax obligations and benefits eligibility to legal protections and liability.

Understanding your worker classification is crucial because it determines your legal rights, tax responsibilities, and access to benefits. The classification also affects your employer’s or client’s legal obligations to you. While the difference may seem straightforward, many workers find themselves in gray areas where classification isn’t immediately clear.

Definition of Employee

An employee is a worker who performs services for an employer under the employer’s direction and control. The employer controls not only what work will be done, but also how, when, and where the employee will perform it. This relationship gives the employee certain legal protections and benefits while also limiting their independence.

Employees work under an employment relationship that typically includes:

• Control and direction: The employer has the right to control the details of how the employee performs their job. This includes setting work hours, determining work methods, providing training, and supervising the work. Even if the employer doesn’t actively exercise all of these controls, having the right to do so is what matters.
• Integration into the business: Employees are integrated into the business’s regular operations. Their work is essential to the employer’s core business activities. For example, a cashier at a grocery store or a teacher at a school is performing work central to those organizations’ purposes.
• Ongoing relationship: The employment relationship often continues indefinitely rather than ending after completion of a specific project. Even if employment is “at-will” (meaning either party can end it at any time), there’s an expectation of an ongoing relationship.
• Economic dependence: Employees are economically dependent on their employer. Most work for a single employer, receive regular wages, and rely on that income. The employer bears the financial risk of the business, not the employee.
• Tools and resources: Employers provide the tools, equipment, and resources employees need to do their work. This can include computers, vehicles, supplies, or workspace.
• Tax treatment: Employers withhold income taxes, Social Security, and Medicare taxes from employee paychecks. Employees receive a W-2 form at year-end showing their wages and withheld taxes.
• Legal protections: Employees receive extensive legal protections under federal and state employment laws. These include minimum wage and overtime protections under the Fair Labor Standards Act, anti-discrimination protections under Title VII of the Civil Rights Act, workplace safety protections under OSHA, and the right to join unions under the National Labor Relations Act.
• Benefits: Employees are often eligible for benefits. These include health insurance, paid time off, workers’ compensation coverage, unemployment insurance, and retirement plans.

Examples of employees include office workers, retail staff, teachers, hospital nurses, construction workers employed by contractors, and restaurant servers.

Definition of Independent Contractor

An independent contractor is a self-employed worker who provides services to clients under terms they control, maintaining independence over how they complete their work. Independent contractors run their own businesses and contract with clients to deliver specific results, but the clients do not control the methods or details of how the contractor accomplishes those results.

Independent contractors operate under a business relationship that typically includes:

• Autonomy and control: Independent contractors control how they perform their work. While clients can specify the results they want, contractors decide when, where, and how to achieve them. They use their own methods and expertise without client supervision or training.
• Multiple clients: Independent contractors can serve multiple clients at the same time. They’re not economically dependent on any single client and can accept or reject work opportunities as they choose.
• Specialized expertise: Contractors bring specialized skills and established expertise to the work relationship. Clients hire them because of their existing knowledge and abilities, not to train them.
• Investment and risk: Independent contractors make investments in their own businesses. They provide their own tools, equipment, workspace, and supplies. They can make a profit if their business succeeds or suffer a loss if it doesn’t.
• Project-based work: The working relationship typically revolves around specific projects or deliverables with defined endpoints. While contractors may work with the same clients more than once, each engagement is discrete.
• Tax treatment: Clients do not withhold taxes from payments to independent contractors. Contractors receive their gross pay and are responsible for calculating and paying their own income taxes and self-employment taxes (covering both the employer and employee portions of Social Security and Medicare). They receive 1099-NEC forms at year-end showing total payments received.
• Limited legal protections: In general, independent contractors are not covered by employment laws that protect employees. This means no minimum wage requirements, no overtime pay, no anti-discrimination protections under employment laws, and no OSHA workplace safety coverage. However, they may have protections under contract law and certain state-specific laws.
• No employment benefits: Independent contractors do not receive employee benefits. They must secure their own health insurance, cannot claim unemployment benefits, are not covered by workers’ compensation, and must fund their own retirement savings.
• Business flexibility: Independent contractors can grow their businesses however they wish. They can hire employees or subcontractors, set their own rates, choose their clients, and develop their own business methods and brand.

Examples of independent contractors include freelance graphic designers, independent consultants, Uber drivers (though this classification has been challenged in some states), licensed plumbers who run their own businesses, contract software developers, and freelance writers.

The key distinction is that employees trade independence for security and protection, while independent contractors trade security for autonomy and business ownership. Neither classification is inherently better. They serve different purposes and suit different situations. What matters is that the legal classification matches the reality of the working relationship.

Key Differences

The following tables break down the key factors for determining whether a job is performed by an employee or an independent contractor.

Work Relationship and Control

Training and Expertise

Compensation and Taxes

Benefits Insurance

Legal Protection and Rights

How To Determine Your Classification

If you’re not sure whether you’re an independent contractor or an employee, start by asking yourself some simple questions. For example:

• “Do I set my own hours? Do I have to invoice my projects to get paid? Can I work wherever I want? Do I have to file a 1099 form and pay my own taxes?” If you’re answering “yes” to the questions, you’re probably an independent contractor.
• “Do I have to work regular hours? Do I have to go to an office or log in at a set time? Do I get a W-2 form every year and file a 1040 to get a federal income tax refund?” If so, you’re likely an employee.

The Internal Revenue Service (IRS) and the Labor Department (DOL) each have separate criteria used to determine a worker’s status. Even if your employer calls you an “independent contractor” and you can set your own hours may not mean you are one for tax purposes. The IRS and the U.S. Department of Labor (DOL), as well as other states, have devised classification tests to see whether your job meets the criteria for an “independent contractor” role.

IRS Common Law Rules

The IRS analyzes the employer-employee relationship under three categories. No single factor determines whether an employee is a contractor. The categories are:

• Behavioral: Does the company control what the worker does and how the job is performed? Can the worker come and go as they please? Who decides when a project is finished?
• Financial: Does the worker use their own tools, or does the employer provide them? Are expenses reimbursed? What business costs are borne by the employer as part of their business operations?
• Type of Relationship: Does the employee receive typical employee benefits (pension, insurance, vacation pay)? Is there a written contract that outlines exactly what the relationship shall be? Is the work performed an integral part of business operations?

The answers to questions like these are analyzed to determine classification.

DOL Economic Reality Test

This is a six-factor analysis. As with the IRS test, no single factor determines whether a worker is an employee or a contractor. The factors focus on:

• Opportunity for Profit or Loss: Does the worker’s own decision-making affect their profit/loss ability? In other words, does a worker make the decisions that increase business opportunities, or are they separate from obtaining clients and making advertising decisions?
• Investments by Worker and Employer: Does the worker contribute to the economic cost of business operations? Do they support the growth of the business in ways other than by daily work?
• Degree of Control: Examines the extent of control the employer has over hiring, firing, disciplining, and terminating the worker. What level of freedom does the worker enjoy in their hours, workplace, attire, and other aspects of employment?
• Permanence of the Relationship: Long-term vs. short-term does not necessarily imply a worker vs. contractor distinction. The test assesses whether the relationship is similar to other permanent relationships with the company (such as seasonal employees) or to other contracted workers.
• Integral Part of Business: Is the worker doing something normally part of the business operations, such as a baker who makes specialty cupcakes for a bakery? Were they hired to perform a specialty function not usually provided by the business, such as a welder hired to repair the baker’s oven?
• Skill and Initiative: Does the worker use their specialized skills independently to develop their own business or work base? The level of skill is not critical. For instance, a highly-skilled writer could be an independent journalist pitching articles to a wide variety of publications, or a writer working for a single company that accepts assignments.

Answers from these factors are used to define the work classification.

ABC Test

The ABC test is a strict, three-pronged test used by many states, including Alaska, Arkansas, California, Connecticut, Delaware, Georgia, Hawaii, Illinois, Indiana, Kansas, Louisiana, Maine, Maryland, Massachusetts, Nebraska, Nevada, New Hampshire, New Jersey, New Mexico, Ohio, Oregon, Utah, Vermont, Washington, and West Virginia. In these states, a worker is presumed to be an employee unless they meet all three prongs of the test:

• They must be free of company control
• They must perform work outside the company’s usual business
• They must customarily engage in an independently established trade

A high level of control can render an independent contractor agreement invalid. The landmark 9th Circuit case Alexander v. FedEx Ground Package Delivery System outlines this very clearly. In Alexander, FedEx drivers were classified as “contractors” by FedEx, and had a written contract stating that “[N]o officer, agent or employee of FedEx…shall have the authority to prescribe hours of work, whether or when the [driver] is to take breaks, what route the [driver] is to follow, or other details of performance.”

In practice, FedEx exercised strict control over its drivers, including when they must accept packages, the hours in which they must be delivered, and when trucks must be at the terminal for pickup and loading. FedEx had sole discretion over when a route could be altered and whether a driver could acquire more customers per route. FedEx also controlled drivers’ attire and grooming, and could send them home for poor appearance.

The 9th Circuit ruled that based on the extensive level of control exerted over the drivers and the minimal freedom for “profit or loss” afforded by the contract, the FedEx drivers were employees, not contractors, and ordered FedEx to treat them as such. The court noted that “the drivers look like FedEx employees, act like FedEx employees, [and] are paid like FedEx employees.”

Examples of Industries With Classification Issues

If you work in any of these jobs, you could have some classification questions. Take a look at what you do and what your employer wants you to do if you are:

• Gig workers (rideshare, delivery drivers)
• Healthcare workers (traveling nurses, locum tenens physicians)
• Tech and IT (coders, developers, consultants)
• Realtors and real estate brokers
• Construction and subcontractors (specialty workers and finishers)
• Creative workers (writers, designers)

This is not an exhaustive list.

Worker Misclassification

Employers may classify workers as independent contractors to evade financial and legal obligations. Misclassification of workers is a common but illegal practice. The U.S. Department of Labor (DOL) ordered a medical staffing agency to pay $7.2 million in back wages and damages for having misclassified employees as independent workers. State and federal laws prohibit misclassifying workers, and business owners who intentionally do so to avoid taxes may be prosecuted for tax fraud.

The Fair Labor Standards Act does not cover independent contractors. This federal law sets minimum wages, work hours, and overtime benefits for employees. It also protects employees in misclassification cases. Two companies that operated quarries violated the Fair Labor Standards Act when they classified delivery drivers as independent contractors, according to a 2021 lawsuit.

Misclassification Consequences for Employees

If employers misclassify workers, they can face financial penalties. Workers can suffer other financial fallout. Being classed as an independent contractor means workers have all the burdens of being a contractor and few of the perks. They still have to clock in and out as if they were employees, but lose the benefits that come with being employees. For example:

• Contracted workers do not have health insurance, pensions, or paid sick leave, even in states that mandate it
• They are not entitled to overtime pay or minimum wage
• At tax time, they must pay self-employment tax and FICA
• Unless they pay into the unemployment tax themselves, they will not have unemployment benefits
• Contractors can be eligible for workers’ compensation in some cases, but most states will not cover their injuries if they are hurt on the job
• Contractors may not have protection under the NLRA and may not be covered under the Civil Rights Act

Self-employed individuals should be aware of these facts going in. California gig workers recently obtained the right to join the Service Employees International Union (SEIU). The average worker may not realize they are “contractors” until they file their tax returns and find out they owe a lot.

What To Do if You’re Misclassified

If you think you’ve been misclassified, speak with your employer if you can. If your written agreement gave you independent contractor status and you’ve been ordered to work 9-5 and wear a uniform, you need clarification on your status.

If you don’t get a good response, you can report your employer to the IRS. Employees misclassified as contractors can file Form SS-8 to request an IRS review of their tax status. You will describe your job and what you do. The IRS will review your answers and then contact your employer for their side of the story. The IRS then makes a determination of whether you are an employee or not.

If they decide you are an employee, you can file a separate form requesting your uncollected Social Security and Medicare payments. If it’s been a while or you’re not sure, you may want to consult an accountant or a tax attorney.

Get Help From an Attorney

Have you been misclassified at your job? It can be difficult to know whether you’re an independent contractor or an employee. Legal options are available. Speak with an employment attorney if you need help with state laws, labor laws, or any other aspect of being an independent contractor.