Doing things right and ethically for the people who work for you should be every organization’s goal and top priority. However, depending on the individual’s classification status, the rules and expectations can differ. The individual can be a freelancer, contractor or employee with the organization.

There is a difference between the professionals you are hiring even if the terms "freelancer" and "contractor" are occasionally used synonymously. Let us understand these classifications better.

What is a Freelancer?

Freelancers are self-employed individuals. Characteristics of freelancers include:

☐ Freelancers pay self-employment tax, which is a form of income tax.

☐ Freelancers have no employees, but may outsource work for certain projects.

☐ Freelancers have complete control over their work environment such as where they work from and the working hours.

☐ Freelancers manage a number of clients and projects at once.

☐ They set their own prices and decide whether to bill by the hour or the project.

☐ They do not receive any benefits from the businesses they work with.

What is a Contractor?

Although contractors and freelancers have many things in common, their roles are disparate. While you might use freelancers for some work tasks, contractors handle more labor-intensive tasks. Your best bet is to hire a marketing firm to perform the work if your company needs advertising services beyond simple account upkeep on social media, for example. They have a group of qualified professionals on staff who can help you gain the exposure you require. Some working characteristics of contractors include:

☐ They are free to work on other things because they are bound by a contract for a specific time period and specific task.

☐ Hiring a company through contract can help in completion of highly specialized work and guarantee the work is done correctly.

☐ There is no need to hire an individual on contract if you as an employer do not deem the project to be an ongoing one.

What is an Employee?

Employees are individuals who work with an organization on a permanent basis. They maybe paid on a monthly, hourly, or commission basis. Some of an employee working characteristics include:

☐ Employees operate on the terms of a contract that specifies the position's duties, pay, and hours.

☐ They are eligible for certain benefits, such as workers' compensation and unemployment insurance, which are also deducted automatically from their paycheck.

☐ Employees usually work from company offices or remotely.

Why is it important to classify the Workers?

Employers will always benefit from thorough classification so that they are paying their workers reasonably according to their engagement. Know why it is important to classify the workers:

1. Employers will know how to manage Income and Taxes

Employers will not be required to deduct income, social security, or Medicare taxes from any pay or salary if they classify the worker as an independent contractor. Self-employment tax will be entirely independent contractors responsibility to pay and report. The tax rates for each type of worker are different, which means that employers can manage their taxes accordingly and claim the right benefits.

Employers take care of an employee’s taxes, even withholding specific amount before issuing paychecks and paying taxes on their behalf to the IT department. On the other hand, freelancers are responsible for paying their taxes, inclusive of income tax. Employers are relieved of managing taxes for both freelancers and contractors. Contractors do get tax write-offs, inclusive of specific home office deductions and claims on business expenses. The employers can deduct a certain tax amount at source even for contractors, as required.

2. Wrong Classification could entail losses for Employers

Employees who have been mistakenly categorized as a contractor, you have forfeited your rights to benefits including health insurance, workers' compensation, overtime pay, and paid holidays.  

Most jobs offer employees benefits that include retirement plans along with paid leaves. Employers clubbing freelancers as employees will force them to offer health insurance, unpaid leave, and other benefits like life insurance, and other insurance options. On the other hand, freelancers and contractors are completely responsible for their taxation, medical insurance and retirement planning. They are not usually granted paid vacation, holidays, or sick days. Employers who need flexibility in their workforce need to classify all workers ideally, so that there are no extra payments where it is not intended.

3. Helps employers to set the right expectations in terms of Jobs, Roles and Responsibilities

Employers should set the right expectations when hiring workers. If they need someone in-house and need consistency in service, you choose an employee. Freelancers and contractors work from gig to gig basis. This classification helps in setting the right expectations from the job roles, the frequency of deliverables and the responsibilities that can be given to them. Employees can be given higher responsibilities with targeted deliverables everyday by the employers, unlike freelancers. Contractors could be assigned a specific timeline for deliverables irrespective of periodic responsibilities, with a lump sum gig-based remuneration.

4. It is the Law

Employers stand to face legal consequences and financial penalties for not classifying or incorrectly classifying their staff. The Income Tax department is also always on the lookout for pertinent cases where companies have not classified their employees, contract workers, and freelancers properly. If they discover that the employers have made a wrong classification, they could impose legal fines and also drive financial consequences. Employers may also have to pay back taxes in full along with penalties for wrong filing.

How to determine your work status if you are misclassified?

If employers have classified their workers incorrectly, it is time to correct the issue. Review the classification with the Income Tax department and sort out all inappropriate categorizations. Provide proofs that there was no malicious intent to contravene the law during classification.

Review the employee and freelancer applications with the IRS. Furnish details about your company's legal structure and the quantity of clients.

Contact the IRS to evaluate the workers and fill out the requisite forms to clarify your stand.

How to determine worker status?

1. Control of behavior

It is probably an employer-employee relationship if the employer has the authority to oversee and guide your job. Whether the employee decides to use that privilege or not, this distinction still stands.

2. Control over finances

Employers when they exert more control over the financial aspects of a worker's employment would entail the following:

☐ While independent contractors often receive payment per assignment or project, employees are given a wage or salary.

☐ In contrast to employees, who are often limited to working for one firm, contractors and freelancers can locate new clients and frequently work with several at once.

3. Company’s relationship

The worker's position is determined by their connection with the employer. Factors can include:

☐ If the company offers perks like overtime pay, a pension plan, or even insurance, it is likely that the worker is an employee.

☐ The organization should categorize workers as employees, and not a contractor or freelancer if they engage them to do the same function and not the primary service.

Manage Employees, Freelancers and Contractors

1. Understand what the workers want from the engagement

One of the most crucial things as an employer to ask is, "What are you offering that person in exchange for giving their time and talent to the company?". What’s more, you must also understand the reasons why the individual is interested in joining your company as a freelancer or an independent contractor. 

2. Define and set expectations

Employers must define and set expectations with the individual working for them, but must also communicate them and clarify that they understand them. Drafting a statement that specifies precisely what you need and when is excellent practice. It is crucial to provide them with background on the task they will perform as well. Freelancers usually juggle a lot of tasks. Helping them understand the importance of specific tasks is essential to getting a 100% work commitment onboard.

3. Make them feel like they are a part of the team

Whether you hire freelancers or employees or contract workers, they enjoy working for companies that make them feel like they are part of the team. Differentiating between them and permanent employees can make them feel inferior and demotivated. It could be any practice from inviting them to important meetings, access to corporate gyms, adding them to the email list and team lunches, etc.

4. Build a professional relationship with them

Build a professional relationship by asking them about their families, how they enjoy spending their day, etc. Also remember to tell them about yourself in the process. This is especially vital if you intend to collaborate with this individual again in the future.

5. Pay them fairly

Avoid thinking about exploiting or loading the freelancer or contractor with extra work just because they are temporarily working for you. Consider paying them well for their time that they devote to you. Word gets around and it becomes difficult for employers with a bad reputation to hire freelancers, contractors or even employees.

6. Do not micromanage

The individuals likely began freelancing or contracting because they want independence. Be accommodating to their schedules and other obligations. Most certainly, you are not their only client. Likewise, allow them room to work. When they are not micromanaged and given their freedom, they will likely work better.

7. Give them concise feedback

Even though there is no requirement for a formal evaluation when working with independent contractors, you must never compromise on the feedback. It may be as easy as taking five minutes at the conclusion of an engagement to talk about what went well and what did not. Thank them if they are working hard for you, especially in front of others. And if they are not performing well, be direct about it.