Hiring an independent contractor is an attractive option for employers looking for specific skills, and with 11.9 million people working as independent contractors as of July 2023, it's a common way to round out a team for a short-term project or an ongoing commitment that doesn't require a full-time employee. But the process isn't as simple as it may seem at first. There are important distinctions between hiring a contractor and an employee that can impact your business. What do you need to account for when deciding how to fill a role on your team?
Not sure if you should bring on your next all-star as a contractor or employee? Wondering if you need to convert an existing contractor to full-time employment? Find out using our Contractor vs. Full-Time Analyzer.
Risks To Consider When Hiring Independent Contractors
The five main risks of hiring independent contractors are: worker misclassification penalties, potential lawsuits and financial liability, creating permanent tax establishment in new countries, intellectual property and data protection vulnerabilities, and high contractor attrition rates. Let's break down each risk and what it means for your business.
1. Misclassification
"Independent contractor" and "employee" are more than just job titles—they're important worker classifications that come with different rights and responsibilities, both on the worker's side and the employer's. Improperly managing these distinctions is known as worker misclassification, which puts you at risk for various fines, penalties, and tax sanctions. According to the IRS, companies can be held liable for employment taxes for any worker they misclassify without a reasonable basis.
As of 2021, the Internal Revenue Service (IRS) defines an employee as "anyone who performs services, if the business can control what will be done and how it will be done." By contrast, they define independent contractors as "people in an independent trade, business or profession in which they offer their services to the public."
The key difference? Businesses have the right to control the details of how their employees work—and must train and compensate them accordingly—but independent contractors have more latitude and assume responsibility for their own training, equipment, benefits, and tax calculations.
There's never a good time to take a risk with how you classify your workers. If you have any reason to believe a contractor should be classified as an employee, you're probably right.
2. Worker Lawsuits And Financial Liability
Here's what keeps CFOs up at night: misclassified contractors can sue for employee benefits they should have received. This risk is significant enough that the IRS offers a Voluntary Classification Settlement Program (VCSP) that allows businesses to proactively reclassify their workers as employees with partial relief from federal employment taxes. One lawsuit can trigger a domino effect with serious financial consequences:
- Back benefits claims: Health insurance, retirement contributions, overtime pay, and stock options
- Legal escalation: Class action suits and Department of Labor investigations
- Ongoing costs: Years of back taxes, penalties, and legal fees
- Global complications: Each country has its own penalties and legal remedies
The hidden cost? Management time spent dealing with litigation instead of growing your business.
3. Permanent Establishment
Here's the thing about permanent establishment: how and where your contractors work can create a taxable presence for you. When that happens, you may discover you actually have employees, not contractors.
Key considerations include:
- Location matters: Tax laws vary significantly between countries
- Control level: The authority contractors have over their work affects classification
- Compliance complexity: Managing multiple jurisdictions becomes challenging without proper tools
4. Data Protection
Without clear stipulations over intellectual property ownership, contractor engagements can dilute your position in the market and undermine data and privacy protections. A lack of clarity in these areas could result in a contractor taking sensitive data with them at the end of their contract. These are challenges few employers can afford.
You have more control over data privacy and protection with an employee. For example, employees are often required to use company-issued hardware while contractors are not. This difference in equipment can leave critical data vulnerable.
5. Attrition And Disengagement
Finding a high-performing contractor feels great—you get their skills without employee overhead. But here's the reality: contractor relationships are inherently unstable.
Why contractors leave:
- Business priorities: They operate as independent businesses with multiple clients
- Better opportunities: No loyalty obligations mean they can easily move to competitors
- Compensation gaps: They may feel disadvantaged by limited benefits, training, and perks. For example, data from July 2023 shows independent contractors are less likely to have health insurance from any source (74.2%) compared to workers in traditional arrangements (84.9%).
- Flexibility needs: Contractors value scheduling freedom over company commitment
Unlike employees, contractors aren't locked into long-term relationships and can change their mind about working with you at any time. However, it's worth noting that a vast majority of independent contractors—over 80%—overwhelmingly preferred their work arrangement as of July 2023.
Hiring contractors may seem like a simple way to scale your team quickly and efficiently, but there are various financial, legal, and operational risks involved. It's important to take a balanced view of both sides of this option to be confident in your decision.
Avoid These Risks By Using Oyster To Convert Contractors To Full Time Employees
On the plus side, there's help available: Oyster's contractor conversion solution can help you assess your risks in different countries, weigh the costs and benefits of both employment models, and compliantly transition contractors to full-time employment. Our contractor vs. full-time employee analyzer will also allow you to confidently assess workers for misclassification risks.
You'll never again have questions or concerns about whether you've made the right decision.
If you're ready to start hiring with Oyster, sign up for a free account today. You'll gain immediate access to Oyster Academy, along with distributed HR tools and the ability to hire and pay your first two contractors.
About Oyster
Oyster is a global employment platform designed to enable visionary HR leaders to find, engage, pay, manage, develop, and take care of a thriving distributed workforce. Oyster lets growing companies give valued international team members the experience they deserve, without the usual headaches and expense.
Oyster enables hiring anywhere in the world—with reliable, compliant payroll, and great local benefits and perks.
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