What Is Contract Labor?

Contract labor refers to when a non-employee provides services to a company under the terms of a contract. Companies hire contract laborers, or contractors, for a specific price and specific duration or until the completion of a particular project.

Businesses often use contract labor for short-term assignments, projects requiring specialized skills or expertise, or tasks outside the company’s core competencies.

A company and the contractor agree to the scope of work, pay rates, and deliverables under the terms of a contract. Contract laborers are responsible for managing their own taxes, benefits, and work-related expenses. The employment relationship terminates once the contract period ends.

Contract labor examples

Many industries utilize contract labor by engaging with contractors, freelancers, and consultants for short-term projects and specialized expertise. Some common examples of contract laborers include the following positions and fields:

Web designers and developers
Graphic design
Content writers and copywriters
Digital marketing and public relations
Business and legal consultants
Accountants
Translators
Customer service
Data entry

What is an employee?

An employee describes a worker who is part of a traditional employer-employee relationship, in which the company controls their work and how they complete it.

What is the difference between an employee and a contract laborer?

The factors determining the difference between employees and contract laborers differ from country to country. However, the differences typically fall under the worker’s rights, responsibilities, and tax implications.

In general, common-law employees follow the control of their employer, while contract laborers operate as separate entities to provide services under the terms of a contract. Some key differences include the following:

Employer relationship. Employees follow rules and duties defined by their employer, such as work days, hours, and pay schedules. Contractors set their schedules, work methods, and fees and often focus on specific tasks or projects outside the core business.
Exclusivity. Employees typically work exclusively for one employer, while contractors may work for multiple clients and projects simultaneously.
Pay. Employees receive regular wages, while contractors often receive payment upon project completion.
Taxes. The employer is responsible for paying an employee’s income tax withholdings, while contractors must manage their own taxes as self-employed individuals.
Benefits. Employees also receive benefits and worker protections, such as healthcare, retirement plans, and unemployment. Contractors, however, must cover their benefits and do not receive employee protection entitlements.

Benefits of using contract labor

Contract labor offers companies many benefits when hiring employees is not the right fit. Some advantages include the following:

Access to top talent. Companies can broaden their talent pool and hire candidates with the most relevant skills and expertise for their specific needs, regardless of location.
Entry into foreign markets. Engaging with global contractors helps companies gain valuable local knowledge and connections to quickly test new markets for future expansion.
Quick and easy onboarding. Onboarding and paying contract laborers is much more straightforward than with employees because contractors do not require the same training, taxes, or benefits.
Workforce scalability. Companies use contract labor to help grow or reduce their workforce as needed and can quickly and easily scale up teams during peak periods and downscale during slower times.
Flexibility. Companies can adjust their workforce based on the demands of specific projects or business cycles without the long-term commitment associated with permanent employment.
Cost savings. Contract labor allows for better control over labor costs, as companies can negotiate specific terms in the contract, including payment rates, project milestones, and deliverables.

Risks of using contract labor

Contract labor offers flexibility and workforce conveniences for employers; however, companies must also understand the associated risks. Contract labor also presents many challenges, including:

Less control. A contractor’s autonomy and temporary nature make it more difficult for a company to control the individual’s work and manage their overall investment in the company's long-term goals.
Transient workforce. A contractor engaging in short-term projects may not be available for ongoing needs, leading to frequent turnover and potential workflow disruptions.
Increased liabilities. Unlike employees, contractors may sue their clients for work-related injuries and retain copyright ownership of their work, risking sensitive company information going to competitors. Employers must be mindful of these increased liabilities and practice due diligence, such as explicitly defining copyright ownership and contractor insurance options in the contract.
Misclassification. Local worker classification laws vary worldwide, and employers must understand the classification differences between their full-time employees and their global contractors. If an employer misclassifies their talent, they face liabilities for unpaid taxes, back benefits, legal fines, and reputational damage.

When engaging in contract labor, both parties must clearly outline the terms and conditions of the contract to avoid misunderstandings or compliance issues.

What are contract labor rules to know?

While contract labor rules differ worldwide, most countries dictate how much influence and control an organization has over a contractor. Companies engaging contractors must adhere to the local labor laws that govern worker classification in the city, state, or country where the contractor lives and works.

For example, the Internal Revenue Service (IRS) determines the worker classification in the United States based on the following categories:

Behavioral control. Does the business have the right to direct and control the work performed by the worker?
Financial control. Does the business have the right to direct or control the financial and business aspects of the worker's job?
Relationship. Does the company provide benefits, will the relationship continue indefinitely, and does the worker perform critical services for the business?

How do you pay for contract labor?

The company and the contractor must establish a pay rate, frequency, and payment method in the contractor agreement. To pay for contract labor, the contractor typically sends the client company an invoice for their hourly or project-based work. The employer provides a paycheck based on the invoice amount and does not withhold income taxes.

Does a business pay taxes on contract labor?

A business does not pay taxes on contract labor. In the U.S., contract laborers fall under the category of 1099 employees.

The 1099 employee fills out Form W-9 for the entity paying them, providing the information the company needs to complete and submit Form 1099-NEC. The company must file Form 1099 to report payments to any contractor paid over $600 within a tax year. Foreign contractors should complete Form W-8BEN to certify they aren’t U.S. taxpayers.

How to avoid the compliance risks of engaging contract laborers

Despite the compliance risks of engaging contract laborers, businesses can mitigate the risks with due diligence. Before engaging contractors, consider the following steps to avoid misclassification penalties and reap the benefits of contract labor:

Review local employment regulations. Familiarize yourself with the varying classification regulations and contractor definitions in each jurisdiction where you engage talent.
Establish clear work agreements. Draft work agreements that clearly define the terms of service, each party’s responsibilities, and the nature of the working relationship to avoid any compliance issues or misunderstandings.
Utilize self-check resources. Use local country resources that help employers correctly classify their workforce, such as the IRS’s list of factors differentiating employees from contractors.
Convert contractors to full-time employees. Avoid worker misclassification risks by converting contractors to full-time employees and developing a cohesive, committed, and competitive workforce.
Partner with a global workforce management expert. Work with a global workforce management expert like an employer of record (EOR) to assist you with contractor compliance. A knowledgeable and experienced EOR partner can help you navigate complex employment regulations, provide guidance on specific circumstances, and ensure compliance with local employment and tax laws.

Hire compliantly with Velocity Global

Contract labor and engaging contractors offer businesses ample opportunities when done compliantly. A global expert like Velocity Global can help you stay on the right side of labor laws and eliminate the worry of building a distributed team.

Velocity Global offers a full suite of global employment solutions and expertise that helps you meet your business expansion goals. As your EOR partner, we handle all risk mitigation, local labor requirements, and compliance to help you build a high-quality, distributed workforce.

When you’re ready to turn your contract labor into a long-term commitment, our Contractor Conversion solution ensures hiring compliance as you develop your international team.

Contact Velocity Global to learn more about our global employment solutions.