Payroll and Taxes

Understanding the Payroll Differences Between Employees and Contractors

Hannah Rau
March 30, 2023
min read

Whether you’re a business owner or looking for work, it’s important to understand the payroll differences between employees and contractors. While employees and contractors may do the same job, they are treated differently for tax and employment purposes. 

This article will examine the differences between employees and contractors, including their payment structures, benefits, and the legal implications of hiring. As an employer, you must understand the differences and classify your workers correctly to protect yourself and your business.

No matter how you classify the people who perform work for your company, know that PayStubs offers an incredibly user-friendly payroll solution to take the guesswork out of paying employees, contractors, or both. 

Differences Between Employees and Contractors

Employees and contractors are two types of workers that businesses may employ. While they might perform the same tasks, there are quite several differences between them regarding their legal status, rights and responsibilities, payment, and benefits. 

1. Payments

A company may hire an individual as an employee to work for them on a more long-term or permanent basis. Employees are under the control and direction of their employer, who is responsible for providing them with the necessary tools and equipment to perform their job. 

They will receive a regular salary on the basis of the agreed pay period. 

In contrast, companies usually hire contractors for a specific project or task. They work independently and are responsible for providing their equipment and tools. Contractors are paid a fee for their services and must look after their own taxes and retirement savings.

2. Benefits

The differences in benefits offered between employees and contractors are pretty straightforward. 

Employees receive a benefits package and additional entitlements such as paid vacation or sick leave. Contractors do not receive any of this. 

Instead, contractors who need insurance benefits will be fully responsible for outsourcing and funding them. Additionally, in most cases, they will not be protected by employment laws and do not receive unemployment benefits. So, contractors may be suddenly laid off unless otherwise specified in their employment contract.

(By the way, PayStubs supports all types of additions and deductions, including paid time off, bonuses, overtime, garnishments, and more!)

3. Taxes

The tax structure also significantly varies between employees and contractors. With employees, companies will withhold the tax from their paychecks and automatically contribute to their taxes and retirement savings. 

Employment laws always protect employees. These laws include regulations on minimum wage laws, workers' compensation, and discrimination laws. Employees are also entitled to unemployment benefits if laid off or fired. 

Contractors get paid according to their agreed-upon fee. At the end of the fiscal year, they must file income taxes. They are also responsible for planning for their savings and retirement.  

Should your Business Hire an Employee or Contractor? 

Are you torn between hiring an employee or a contractor for your business? When hiring, businesses must consider the differences between hiring an employee and a contractor. 

You may want to hire an employee, which typically means you’re ready to take on the responsibility of providing benefits, taxes, and a regular salary. 

On the other hand, if you plan to hire a contractor, the contractor will work independently and be the one to handle their own taxes and benefits. 

Whether to hire employees or contractors depends on your business’s specific needs and budget. 

For example, if ongoing work needs a high level of control and supervision, you may choose to hire an employee. If the work is short-term, specific, and requires a specialized skill set, you may be better off hiring a contractor. 

Another factor to consider is the level of flexibility needed, since contractors are usually more likely to accommodate fluctuating workloads. The decision ultimately depends on what your business requirements are and the financial circumstances of your business as well. 

Do the necessary homework and carefully weigh the pros and cons so you can make an informed decision that will best serve your business needs.

Legal Risks of Hiring Employees and Contractors

Hiring workers, whether employees or contractors, comes with legal risks. By being aware of the legal risks of hiring workers and taking steps to mitigate them, businesses can protect themselves and operate successfully.

Employment laws

When hiring employees, businesses must comply with various employment laws, including minimum wage, overtime, or discrimination laws. Failure to comply with these laws can result in legal action, fines, and damage to a company's reputation. 

Unlike employees, contractors are not subject to the same laws and regulations, making it crucial for businesses to ensure they don't mistakenly classify them as employees. Misclassification of an employee or contractor can result in costly legal action, steep fines, and an audit which might end in higher taxes for the business. 


Another legal risk of hiring workers is protecting confidential information and intellectual property. Businesses must ensure that employees and contractors do not disclose confidential information or use company-owned intellectual property for personal gain.

Any failure to do so could lead your company into a serious legal mess, including hefty fines and legal action. Not to mention, irreparable harm to your company's reputation. 

Businesses must be extremely cautious in their efforts to protect their intellectual property and confidential information. Further, they must carefully assess all potential risks and threats to mitigate any legal hazards that may arise. 

How to Avoid Legal Risks

The best way to avoid these legal risks is by meeting with a legal professional to ensure you’re complying with the correct employment laws and to make sure you’re classifying those you’re hiring correctly. 

Implement policies and procedures to protect your company’s confidential information and intellectual property. You may even need to shop around for the right insurance coverage to protect your business from potential legal damages. This work will pay off in the long run!

Key Takeaways: Employees vs. Contractors

Understanding the differences between employees and contractors is essential for businesses to make informed decisions regarding hiring practices. 

While employees offer more control and stability, contractors provide more flexibility and specialization. Both options have legal risks that a smart business owner can easily prevent. 

Ultimately, whether to hire employees or contractors should be based on the specific requirements and circumstances of the business. By carefully considering the pros and cons and mitigating legal risks, businesses can make the best decision for their needs and operate successfully.

Remember, whether you’re paying contractors, employees, gig workers, or any combination of these, PayStubs makes it easy to manage your payroll in just a few clicks. Try it today!

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