Subcontractor vs. Employee: Everything You Need to Know as a Business Owner
Even though subcontracting and employment might seem interchangeable, these roles are actually quite different when it comes to employment law and employer responsibilities.
Subcontractors and employees can serve valuable roles for your company as it grows, but knowing the major differences in employment status protects you both legally and professionally.
In this guide, we’ll explore the most important differences between subcontractors and employees, and you’ll better understand how each one guides your business decisions.
*Disclaimer: This article should not be considered tax advice, and you should not rely on using it to file your taxes or comply with labor laws. Seek professional guidance for assistance when filing your taxes and making compliant hiring decisions.
What is a contractor?
A contractor is a qualified professional who takes on contract work or temporary roles and assignments. In many instances, contractors consider themselves self-employed business owners. In this context, if you currently own your own service business, you’re considered a contractor.
A contractor’s job responsibilities can include:
- Securing more contracts for upcoming work
- Delegating or sharing work assignments with others
- Overseeing administrative tasks (like invoicing or bookkeeping)
- Managing client relationships
- Performing duties associated with a service business (general contracting, lawn maintenance, painting, plumbing, etc.)
Keep in mind: Many service-based businesses think about “contracting” in the context of a qualified general contractor, or GC. But general contracting is only one small part of the world of contract labor and services. There are many types of contractors, all serving with unique skills in a variety of industries.
READ MORE: Learn about the difference between contractors and handymen
What is a subcontractor?
A subcontractor is a qualified individual who works for another contractor.
Subcontractors complete tasks within a project that the contractor can’t do themselves. Sometimes, a contractor brings on other individuals when they are at capacity for the work they can realistically complete in a given timeframe. In other cases, there are extenuating circumstances (such as needing specialized skills) that make subcontracting the right choice.
For example, a contractor who owns a lawn care business may hire a subcontractor to shovel and plow snow for clients during the winter.
In terms of labor laws, subcontractors are considered self-employed (operating as sole proprietors) and are responsible for their own taxes, supplies, health benefits, and more. The subcontractor can accept or reject new projects, work according to their own timelines, and negotiate price per job.
Subcontractors are common in many service-based industries, including:
- Lawn care
- Painting
- HVAC
- Electrical
Pro tip: Because many subcontractors aim to complete as much work as possible in a short time, their turnaround for deadlines may be faster than full-time employees.
What is an employee?
An employee is a professional who works for an employer (in this case, a contractor) on a consistent, permanent basis. They can be either full-time (40-hours/week) or part-time, depending on the number of hours they’re assigned.
A company employee is not considered to be a self-employed business owner. As a result, the employer is responsible for providing health benefits, vacation time and sick days, work supplies and equipment, and employer-covered tax deductions.
Unlike self-employed contractors, employees agree to the work and scope assigned by their employer. Employees are either paid hourly or by salary, which is paid out on a recurring schedule.
As the owner of the company, create a work environment that cultivates people wanting to stay.
It’s simple things—like making sure that you’re organized, that [your team] has what they need every day to do their job.
If you offer incentives or bonuses, deliver on that.
LISTEN AND LEARN: Hiring Outstanding Employees (and Retaining Them)
What’s the difference between a subcontractor and an employee?
The main difference between a subcontractor and an employee is that a subcontractor is hired to complete specific tasks within a set project, and their work ends once that project is over.
Subcontractors have the freedom to choose their work projects and working hours, but they do not get traditional employee benefits—like employer-sponsored health insurance or 401(k) contributions.
On the other hand, an employee works for the same employer on a consistent, permanent basis. After hiring, they do not need to renegotiate or sign a new contract once they finish their work for the day or month.
Although an employee has to abide by the rules set forth by their employer, they also get several perks and protections. This includes employer-sponsored retirement plans, PTO, and other valuable workplace benefits.
Subcontractor vs. employee: What are the employment tax rules?
According to the IRS, here’s how to distinguish between the two roles (when it comes to taxation and financial purposes).
“The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”
At the same time, the IRS also clarifies: “You are not an independent contractor if you perform services that can be controlled by an employer (what will be done and how it will be done). This applies even if you are given freedom of action. What matters is that the employer has the legal right to control the details of how the services are performed.”
Point to remember: A worker who sets their wage, hours, and chooses the jobs they take on is a contractor or subcontractor, while someone whose employer specifies their wage, hours, and work tasks is an employee.
Comparing employment and contracting characteristics
This chart helps to showcase the main differences between employees and contractors:
| Qualifying characteristic | Subcontractor | Employee |
| Taxable income | Pays their own taxes | Has taxes deducted automatically by their employer |
| Supplies and equipment | Provides their own supplies, office space, and equipment | Is given supplies, office equipment, and a workspace by their employer |
| Work schedule | Sets their own hours independently, may work outside of normal business | Receives specific work hours from an employer |
| Salary and earnings | Sets their own wage per project or per contract | Paid a wage determined by their employer or HR team |
| Freedom of choice | Can reject or accept jobs based on availability or personal preference | Cannot reject tasks or assignments that fall under the responsibilities of their role |
Benefits and incentives | Does not receive health benefits, vacation or sick days, or unemployment insurance through the contractor | May be entitled to corporate health benefits, vacation and sick days, and unemployment insurance through their employer |
Multiple jobs | Can work for multiple clients or businesses | Usually only works for one employer with a W2 employee status |
| Predictability of work | May not be offered consistent work by one contractor | Is hired on a permanent basis, until termination |
Frequency of payment | Receives payment after a job is complete | Receives pay consistently on a determined schedule (bi-weekly, monthly, etc.) |
Tax forms for subcontractors vs. employees
According to tax and employment laws, contractors, subcontractors, and employees all meet different criteria according to tax and employment law.
Subcontractors pay their own employment, social security, unemployment, and medicare taxes. Employers, however, must pay all of these taxes for their employees. That means that if you’re a business owner who hires full-time employees, you are responsible for providing W-2 forms to your employees and 1099 forms to your subcontractors.
Who is responsible for employment taxes?
As a general rule, subcontractors are responsible for paying their own taxes while employees share that burden with their employer. (For example, a full-time employee still contributes to taxes like Medicare out of their gross pay, but they do not pay the full amount since the employer contributes a percentage.)
The forms for employees and subcontractors differ in the US and Canada. Based on your location, here’s what to do if you are a service-based employer:
- Provide W-2 forms (a T4 slip in Canada) to employees in the US at the end of each year for tax purposes. It’s your responsibility to file them in the new year with the IRS (or the CRA in Canada).
- File a completed W-9 form from every non-employee (subcontractor) before sending them a completed 1099-MISC form. A W-9 form gives you the contractor’s valid tax ID number and address, which is necessary for completing a 1099-MSC form.
- Complete a 1099-MSC form for every subcontractor that you have paid $600 or more during the calendar year. As a business owner, you are required to report this expense, and the subcontractor must report their income to the Internal Revenue Service (IRS).
READ MORE: 30 small business tax deductions to save money when filing
Choosing between employees and subcontractors
In the course of running and growing your business, you’ve probably already seen how subcontractors and employees can each serve different purposes.
When you need a specific specialized skill for certain time periods, turn to subcontracting. But when you want ongoing working relationships and need long-term professional commitments, making hiring your first full time employee can be a smart choice.
Keep in mind, however, that contracting and employment don’t have to be mutually exclusive within your business. Depending on your industry and goals, you’re free to experiment and use a mix of both.
The most important thing is to understand what your legal obligations and responsibilities are so that you can become a better entrepreneur and leader.
Originally published November 2019. Last updated on August 30, 2024.
Frequently Asked Questions
-
An employee works directly for a company and is subject to the company’s control (in terms of hours worked, project scope, and salary). An independent contractor, however, operates as an independent entity. The IC provides services to a person or company under the terms of a contract, enjoying more autonomy over responsibilities and timing.
-
When it comes to tax purposes, W2 employees have federal taxes like Social Security and Medicare withheld by their employer. In other words, the employer is contributing to these taxes on the worker’s behalf. Subcontractors are in charge of paying their own self-employment taxes, including both the employer and employee portions of Social Security and Medicare.
This is one of the reasons why subcontractors and self-employed workers need to set aside a higher percentage of their gross pay or income. -
Traditional employees typically receive corporate-sponsored benefits like employment insurance, paid time off (PTO), and retirement plans or 401(k) contributions from their employer. Subcontractors do not receive these benefits. Instead, they’re required to secure their own insurance plans, retirement contributions, and other entitlements or perks.
-
From an employer perspective, working with and hiring full-time employees offers more control over how the work is done. This arrangement might also foster long-term loyalty and a productive company culture. On the other hand, the independent contracting model provides greater flexibility, can be more cost-effective for short-term or specialized projects, and reduces the employer burden of providing salaried benefits.
-
Working with contractors can help you grow quickly, but you should always abide by fair labor laws to avoid worker classification. To make sure you receive the work you’re paying for, it’s also wise to sign a two-way independent contractor agreement. A document like this can be legally binding, ensuring that a contractor delivers on the work they’ve promised—and that you’re not out your investment.