The distinctions between employees and contractors can be confusing, but it’s important to correctly classify the workers you pay. Both positions have different tax obligations for your business.
Contractors in the US
The primary difference between an employee and a contractor is the degree of control you have over how the worker does their work. The IRS categorizes these distinctions as behavioral, financial, and relationship.
An employee:
- Reports to you, or to someone else who works for you. You or your business control when, where and how the employee’s work is done, and measures their performance
- Uses your business’s resources and materials to do their work
- Is paid a regular wage, with income tax and other statutory deductions withheld
- Has the expectation of an indefinite relationship with you, with no fixed term of employment
- Receives a W2 at the end of the year
A contractor:
- Has individual control of when, where, and how they perform their work. Your business has input on the final product, but the contractor controls the process
- Uses their own resources and materials to do their work
- Is generally paid a flat fee for a project, and is subject to self-employment tax
- Works on a fixed contract or term, with an intended end date
- Receives a 1099-NEC form at the end of the year if you've paid them $600 or more
Incorrectly classifying a worker who is an employee as a contractor will have serious tax implications for your business. If you misclassify an employee as a contractor, that means you aren’t paying federal employment tax, as well as other statutory deductions like Medicaid and Social Security. Your worker is also not covered by unemployment insurance and worker’s compensation.
To protect your business, it’s important to evaluate your relationship with your workers according to federal law, and treat them accordingly. Failure to do so could result in financial penalties including requirements to pay back wages and taxes.
While the IRS notes that there is no “magic formula” for determining the status of a worker, consider whether you have an ongoing relationship with a worker, pay them regularly, and/or if they work out of your business location or use your materials or resources. These elements indicate that a worker should be classified as an employee.
If you’re still unsure, the IRS can help you classify your workers using Form SS-8.
Contractors in Canada
The primary difference between an employee and a contractor is whether the person is engaged to carry out services as a person in business on his or her own account, or as an employee. The CRA groups these distinctions into the degree of control the worker has, ownership of tools or equipment used, and level financial risk/opportunity for profit.
An employee:
- Reports to you, or to someone else who works for you. You or your business control when, where and how the employee’s work is done, and measures their performance
- Uses your business’s resources and materials to do their work
- Is paid a regular wage, with income tax and other statutory deductions withheld
- Has the expectation of an indefinite relationship with you, with no fixed term of employment
- Receives a T4 slip at the end of the year
A contractor:
- Has individual control of when, where, and how they perform their work. Your business has input on the final product, but the contractor controls the process
- Uses their own resources and materials to do their work
- Is generally paid a flat fee for a project
- Works on a fixed contract or term, with an intended end date
- Receives a T4A slip at year-end if you've paid them more than $500 in a calendar year
Incorrectly classifying a worker who is an employee as a contractor will have serious tax implications for your business. If you misclassify an employee as a contractor, that means you aren’t paying statutory deductions such as Canada Pension Plan (CPP) contributions and Employment Insurance (EI) premiums.
To protect your business, it’s important to evaluate your relationship with your workers according to the CRA, and treat them accordingly. Failure to do so could result in financial penalties including requirements to pay back wages and taxes.
If you’re still unsure, the CRA can help you classify your workers.