The primary distinction between contract employees and full-time workers revolves around differences in the employer-employee relationship and tax liabilities. 

Typically, a contracted worker has more independence over how they complete their work and is responsible for their own taxes, while a full-time employee works under the direction and supervision of an employer who reports their taxes. For a small business, working with contracted and full-time employees can have advantages for both the employer as well as employees.

In this guide, we’ve covered some of the key differences between contract workers and full-time employees and how you can ensure you have the best workforce for your business.

What are contract workers?

Contract workers, or independent contractors, are generally hired for specific projects or services on a shorter-term basis. Contract workers are not expected to be offered long-term employment or benefits.

The requirements for classifying an employee as a contractor include:

• Responsible for their own taxes
• Use their own equipment and supplies 
• Provide an invoice upon completion of work

Contract workers are becoming an increasingly attractive option for businesses. In fact, 90% of businesses said they intend to increase or maintain their use of contractors at current levels. Additionally, 33% of business owners said their company’s success is dependent on having access to contractors.

What are full-time employees?

Full-time employees, also known as common-law employees or W-2 employees (based on the W-2 tax form they receive), are supervised by their employer, who directs and controls their work throughout a long-term relationship. The employer must pay payroll taxes for each of their full-time employees, as well as provide them with certain legally required benefits.

According to the IRS, there are three factors for businesses to consider when classifying workers as either full-time employees or contracted workers:

1. Does the employer have control over behavior?
2. Does the employer have control over how they’re paid?
3. Is there is an expectation of a long-term relationship with the employer?

If you answered yes to most or all of these, it’s likely that the individual would be considered a full time employee.

What are the differences between contract employees and full-time workers?

While there is no exact definition of either contracted or full-time workers, the main differences between contract employees and full-time employees are the degree of the employer’s control over their work and the manner in which their taxes are reported to the IRS.

Here is a general overview of how to understand the major difference between contracted workers and full-time employees:

• An independently contracted worker performs their services separately from the business that contracts them. The contract employee also pays taxes on the money they are paid by their client, the business.
• A full-time worker functions as part of a business, with their employer reporting their taxes and providing them with direct supervision over the work they perform.

While contracted employees often tend to be cheaper for a business (since employers do not need to offer them fringe benefits such as health insurance or pay payroll taxes for them), there have been issues in the past where businesses have misclassified full-time employees as contracted employees, resulting in significant tax penalties and fees.

To help small business owners properly classify employees, the IRS has guidelines which provide assistance in defining different types of workers.

Understanding the distinctions between contracted and full-time employees is crucial for a small business seeking to expand or enhance its workforce.  

Understanding the differences between contracted and full-time employees is not only crucial for tax and employment classification but also significantly impacts health insurance considerations. While full-time employees often receive health insurance benefits from their employer, independently contracted workers typically do not. This means that contractors are usually responsible for obtaining their own health insurance coverage, which can be a significant factor in deciding between full-time and contract work. This distinction highlights the importance of understanding employment status in relation to benefits like health insurance, especially for those navigating their options in the workforce.

Healthcare coverage for full-time employees and contract workers

Businesses are not required to offer health insurance to their employees, but this is typically a way for you to attract the most talented candidates in your field. If you run a business, you should consider offering health insurance to your full-time employees. Even if you do not cover 100 percent of the health insurance premium, it should be heavily subsidized. Additionally, once you pass a certain threshold of employees—specifically, 50 or more full-time employees—you’re legally required to provide ACA-compliant healthcare coverage, or you’ll have to pay a fine. Make sure to look into employer health insurance requirements as you approach that threshold.

If you have contract employees, you are typically not required to offer them health insurance. Even though you might decide to offer them a short-term health insurance plan, most contract employees understand that they will bounce from company to company. Therefore, they will probably have their own self-employed health insurance plan that they paid for out-of-pocket.

ICHRA plans can be a great solution for both full-time and contract workers. The Individual Coverage Health Reimbursement Arrangement (ICHRA) offers numerous benefits, especially for contract workers. With ICHRA, contract workers have the flexibility to select and purchase their own individual health insurance coverage, tailored to their specific needs and preferences. Unlike traditional group health insurance plans, ICHRA allows contract workers to access tax-free funds provided by their employer to help offset the cost of premiums and qualified medical expenses. This empowers contract workers to take control of their healthcare choices while still receiving financial support from their employer. Additionally, ICHRA provides portability, as workers can maintain their coverage even if they change jobs or transition to a different contract. Overall, ICHRA offers contract workers greater flexibility, choice, and financial assistance in obtaining comprehensive health insurance coverage.

What are the downfalls of including contract workers in healthcare insurance 

When considering offering health insurance to contract workers, here are some key points to keep in mind:

• Bargaining Power Impact: Providing health insurance to contract workers might affect your negotiation leverage with insurance providers. Typically, companies receive discounted rates due to bulk enrollment of long-term, full-time employees.
• Plan Duration vs. Contract Length: Contract employees often work for shorter periods, usually a few months. This mismatch can complicate health insurance arrangements, as standard plans are designed for longer-term employment.
• Post-Contract Coverage: If you offer a longer-term health insurance plan to a contract employee, you might find yourself covering their insurance even after their contract with your company has ended.
• Weighing Pros and Cons: It’s essential to carefully consider the advantages and disadvantages before deciding to extend health insurance benefits to contract employees. This decision can have significant implications for your business’s finances and insurance arrangements.

What are the benefits of including contract workers in healthcare insurance

On the other hand, you may enjoy a few benefits if you offer your contract workers health insurance. 

Offering health insurance to contract workers can bring several benefits to your business including:

• Attracting Talent: Providing health insurance may make your business more appealing to potential contract workers. This can be a significant advantage in attracting skilled professionals.
• Encouraging Longer Commitments: Contract workers might be more inclined to take on longer or ongoing projects with your company, leading to increased stability in your workforce.
• Competitive Edge: Since approximately 51% of contractor workers do not receive healthcare benefits, offering this perk could set your company apart from competitors.
• Tax Deductions: Covering health insurance costs for your contract workers might qualify for tax deductions, depending on your business’s specific circumstances. It’s important to understand your eligibility for these deductions.

What other benefits could businesses offer to contract employees

Offering contract workers the right incentives can benefit your business. In addition to health insurance, you could also consider offering:

• HSA Plan: You might want to offer your contract employees an HSA plan. Many contract employees have to cover a lot of medical expenses out of pocket, and they can save money on their taxes with an HSA plan.
• Paid Time Off:  if your contract employees are going to be with your company for several months, you may want to offer them some paid time off. This will give your contract employees a bit more flexibility, and they will be more likely to be productive while they are there.
• Retirement Benefits: Even if your contract employees are only there for a few months, you may want to consider offering them access to retirement benefits. For example, you may want to look into setting up a Keogh plan for your contractors.

Get creative with the benefits you offer your contractors if you want to attract the best talent. 

Frequently Asked Questions

Are contract employees eligible for employer-sponsored health insurance?

Contract employees may be eligible for employer-sponsored health insurance depending on the terms of their contract and the policies of their employer. While some employers offer health insurance benefits to both full-time employees and contract workers, others may only extend coverage to full-time staff. It’s essential for contract employees to review their contract and discuss health insurance options with their employer to understand their eligibility for employer-sponsored coverage.

How do health insurance premiums compare between contract and full-time employees?

Health insurance premiums can vary between contract and full-time employees based on factors such as employer contributions, plan options, and coverage levels. In some cases, contract employees may have access to the same group health insurance plans as full-time employees, with premiums shared between the employer and the employee. However, contract employees purchasing health insurance on the individual market may face higher premiums compared to those enrolled in employer-sponsored plans. It’s advisable for contract employees to compare available health insurance options to determine the most cost-effective coverage for their needs.

Are there any tax benefits for contract employees purchasing their own health insurance?

 Contract employees purchasing their own health insurance may be eligible for tax benefits, particularly if they utilize a Health Savings Account (HSA) or qualify for premium tax credits through the Health Insurance Marketplace. Contributions to an HSA are tax-deductible, providing contract workers with valuable tax savings on their healthcare expenses. Additionally, premium tax credits are available to eligible individuals and families with low to moderate incomes, helping to offset the cost of health insurance premiums purchased through the Marketplace. Contract employees should consult with a tax advisor or healthcare navigator to explore potential tax benefits and maximize their savings on health insurance costs.

Short-Term Notice 2024