Contractors vs. employees: Choosing for your business

Photo by Lauren Carnes

Staying compliant with IRS rules for classifying contractors vs. employees can feel daunting for small business owners. After all, misclassification isn’t just a paperwork issue—it could expose your business to fines, reimbursement for wages and benefits, or even lawsuits. 

So how do businesses make sure classifications are correct?

This guide breaks down the key differences between hiring employees vs. independent contractors, along with criteria for navigating gray areas and staying compliant for both hiring categories.

Disclaimer: This article is for informational purposes only and does not constitute legal or tax advice. Employment classification rules vary by jurisdiction—consult a qualified attorney or tax professional for guidance specific to your situation

Understanding the difference between contractors and employees

In the best-case scenario, the difference between an independent contractor and an employee will be obvious. For example, you might hire a contractor for a one-time project, such as building a website, versus hiring an employee to handle regular operations.

Other times, the distinction isn’t so clear. Here are some key criteria of each position to highlight the differences.

	Independent contractors	Employees
Contract type	Hired for short- or long-term projects on a contract basis	Hired for ongoing work, typically with an annual salary
Work scope	Often work with multiple companies or clients at the same time	May be full-time or part-time, but work for a single employer on an ongoing basis
Compensation	Paid per hour or per project upon completion, usually via invoice	Typically paid biweekly or monthly through payroll
Autonomy	Retain autonomy in how, when, and where work is completed	Follow employer rules for hours, location, tools, and method
Skills	May possess niche or specialized skills, but companies don’t have a hand in professional development	Partake in internal upskilling and career development programs
Onboarding	Undertake project-focused onboarding	Undergo a full-scale onboarding process, with modules on the company mission, structure, and duties
Tax	Payment not subject to tax withholding, though businesses may be responsible for tax documentation, such as W-9 and Form 1099-NEC	Employer responsible for withholding tax and administering tax documents, such as W-4 and W-2
Benefits compliance	Responsible for paying for their own benefits and health insurance	Provided with an employee benefits package
Business travel	Travel paid out of own pocket	Employer reimburses expenses
Employment law	Not covered by most employment regulations	Protected by state/federal regulations, such as the Fair Labor Standards Act, which specifies standards for minimum wage and overtime pay.

Generally speaking, independent contractors are hired for short- or long-term projects, and they retain autonomy in their hours, location, and work station setup. As self-employed professionals, they tend to work with multiple clients and get paid when work or milestones are completed. They’re also fully responsible for compliance tasks, such as self-employment tax, benefits, and insurance.

In contrast, employees are fully integrated and loyal members of a business. They follow designated workplace rules for hours and location. As an employer, you’re responsible for paying regular salaries, offering benefits, and withholding tax. 

Whether you hire an independent contractor or employee, HoneyBook keeps your creative business compliant and efficient by handling everything from contracts and invoicing to payment processing.

Key criteria for determining independent contractor vs. employee worker status

If you’re not sure whether a new hire should be classified as an independent contractor or an employee, use these four criteria to guide the decision.

Behavioral control

Assess how much control your business has over how and where the hire works:

• Employee: You dictate hours, location, and working methods.
• Independent contractor: The professional decides their own schedule, work location, and methods.

Financial control

Consider who pays for the tools, equipment, and other resources required for the work:

• Employee: Your business purchases or reimburses working tools and equipment.
• Independent contractor: The professional is responsible for their own workstation, tools, and equipment.

Relationship of the parties

Consider the overall working relationship, particularly the contract type and benefits:

• Employee: The contract is for ongoing work and includes a job package with benefits like paid time off and health insurance.
• Independent contractor: The relationship is project-based and your business doesn’t provide a benefits package.

Nature of the work

Assess whether the services rendered are core or permanent to your business:

• Employee: The professional performs core tasks in your business, such as florist at a flower shop.
• Independent contractor: The professional provides specialized services outside your core operations, such as a graphic designer for a flower shop.

Pro tip: Be aware that formally defining a new hire as an “independent contractor” in a written agreement won’t cover your liability. The IRS looks at the reality of the situation, not the contract itself.

Taxes and compliance checklist: Independent contractor vs. employee

Whether you hire an independent contractor or an employee, you’re still responsible for employment tax due diligence and other compliance responsibilities. 

Here’s how your duties vary depending on the worker classification. 

If the worker is classified as an employee

Here are the tax and compliance duties you must handle for employees:

• Withholding responsibilities: Withhold federal and state income tax, and Social Security and Medicare taxes (FICA).
• Other required payments: Pay federal unemployment tax (FUTA) and state unemployment insurance (SUI).
• IRS forms: Collect W-4 Forms and issue W-2 Forms.
• Regulatory compliance: Comply with wage and hour laws set by the Department of Labor, such as minimum wage and overtime pay. Follow applicable state labor laws for benefits, like paid sick leave and workers’ compensation.

If the worker is classified as an independent contractor

Here’s what you’re responsible for when working with independent contractors:

• Withholding responsibilities: You’re not required to withhold any taxes. You only make gross payments.
• Other required payments: You’re not responsible for unemployment or insurance payments.
• IRS forms: Request W-9 Forms, and issue 1099-NEC Forms when payments total $600 or more in a year.

Regulatory compliance: Avoid treating the worker like an employee, meaning no required hours, no direct supervision, and no benefits. Ensure the classification can withstand IRS and state agency scrutiny.

Pros and cons of hiring employees vs. independent contractors

To help you choose the right hiring approach, here’s a quick look at the pros and cons of hiring employees vs. independent contractors.

	Independent Contractors	Employees
Pros	Lower upfront costs: No payroll taxes, benefits, or unemployment insurance requiredMore flexibility: Easier to hire for short-term projects or specialized workFaster onboarding: Fewer administrative and compliance requirementsScalability: Useful for testing roles before committing to long-term hires	Greater control: Ability to set hours, manage performance, and define how work is doneStronger commitment: More integrated into the company’s mission and growthBetter for core roles: Ideal for work central to your creative businessEasier long-term planning: Supports leadership development, retention, and internal growth
Cons	Less control: No dictating schedule, methods, or day-to-day supervisionMisclassification risk: Potential to trigger audits, penalties, and back taxesLimited loyalty: May prioritize other clients and leave more easilyWeaker long-term continuity: Harder to build institutional knowledge and team culture	Higher cost: Involves paying payroll taxes, benefits, insurance, and compliance costsLess flexibility: Legal care required for termination, role changes, and restructuringAdministrative burden: Ongoing management of payroll, HR compliance, and labor law obligations

Both independent contractors and employees have their place in the business world. As you make hiring decisions, keep in mind these pros and cons of each. Overall, independent contractors are ideal for accessing niche skills and handing off project tasks with minimal supervision and top flexibility. If you seek consistent, loyal team members that you manage directly as part of core business, opt for employees. 

Pro tip: You don’t have to choose just one type for your workforce. Hybrid teams offer balance for creative businesses that could benefit from both working relationships. 

Fulfill workforce compliance friction-free with HoneyBook

Knowing how to properly classify independent contractors and employees is a major win in keeping your small business compliant.

As you determine your workforce composition, use the guidance we’ve shared to determine the right worker category. HoneyBook can take care of the rest, helping your creative business adhere to legal standards while keeping operations organized.

Our AI-powered platform helps you manage projects, contracts, and workflows—whether you work with independent contractors, employees, or a hybrid team.

Sign up with HoneyBook to stay on top of every compliance task. 

FAQ

Is it better to hire contractors or employees for a creative business?

It depends on your business stage and goals. Independent contractors offer flexibility and lower commitment, while employees provide consistency and long-term support. Many creative businesses start with contractors and transition to hybrid teams as they grow. 

How do taxes differ for contractors vs. employees?

Independent contractors are responsible for paying their own self-employment taxes and managing their own withholdings. In contrast, employers must withhold and contribute payroll taxes for employees.

What are the risks of misclassifying contractors as employees?

Misclassification can lead to tax penalties, labor fines, and legal issues. It can also harm your reputation and damage trust with your team. It’s important to understand the rules, so consult a qualified professional if you’re unsure.

How do you decide whether a role should be a contractor position or an employee position?

Clarify the scope of work upfront to know the right worker type. Roles that require ongoing work, set hours, and close supervision are usually better suited for employees. Project-based or specialized work with more independence is ideal for contractors. 

Can HoneyBook be used to manage both independent contractors and employees?

Yes, HoneyBook supports both independent contractors and employees by centralizing projects, contracts, communication, workflows, and payments, helping creative businesses stay organized as their teams evolve.