It’s important to correctly classify the workers you pay, as both positions have different tax obligations for your business.
Incorrectly classifying a worker who is an employee as a contractor can have serious tax implications for your business. If you misclassify an employee as a contractor, you aren’t paying the appropriate employment taxes and other statutory deductions. Your worker is also not covered by unemployment insurance or workers’ compensation.
What is an employee?
An employee is a worker, assistant, or staff member engaged in labour for a business or individual.
With employees, the employer is the one who controls what work must be done, pays taxes on the employees’ behalf, and covers operating costs, amongst other things.
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
- Receives a tax form at the end of the year. If your business is in the United States, employees receive a Form W2. If your business is in Canada, employees receive a Form T4.
What is a contractor?
A contractor is a person or business that performs work or supplies materials for your business. They are typically hired to complete specific projects or tasks, but are not part of your business.
Contractors help your business complete certain predefined tasks, and in exchange, you pay them an agreed-upon amount for their work. Contractors also pay their own taxes.
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 year-end tax form if they meet the requirements. If your business is in the United States, eligible contractors receive a Form 1099-NEC. If your business is in Canada, eligible contractors receive a Form T4A.
If you’re still unsure if you have employees or contractors, for business in the United States, the IRS can help using Form SS-8. For business in Canada, the CRA can help you classify your workers.