An internal contractor, also referred to as a consultant, is a freelancer who doesn’t work as a permanent employee of the company he is doing work for. While there seems to be no difference at all in terms of working alongside employees and doing the same type of work that employees do, there are some key legal differences between an employee and an internal contractor.

It is common for companies to employ internal contractors in a number of job functions, including lawyers, doctors, writers, web content designers, secretaries, painters, electricians, and more. However, when companies choose to hire such individuals, they should be mindful of the requirements for identifying them as internal contractors and not employees of the firm.

Internal Contractor Defined

When determining if an individual is an internal contractor, the Internal Revenue Service (IRS) will look at 3 elements:

  • Control over the work
  • Financial control
  • Relationship

A company will enter into a contract with its employees by stating what type of role the employee has, and the type of work that is expected under the employment contract. Therefore, if the employee does a certain amount of work every day, with no variation in hours or scope, then he will be considered an employee. However, if there is less control over the person, and the work is being done over different days, weekends, and hours, then he will be classified as an internal contractor.

If the company has less financial control over the individual, then it will likely deem that person an internal contractor. Therefore, the IRS will look to how the person is paid, how taxes are paid, etc. If the person receives benefits and an annual salary from the employer, he will be considered an employee.

The IRS will also look at the overall relationship between the company and person. Does the person benefit in any way from what is being offered by the company, particularly in terms of insurance and other vacation benefits? Does the person work for another company? If they determine that the employee has several contracting jobs, then the employee will be considered a contractor.

Employee vs. Internal Contractor

There are many factors that one can look at to determine if someone is an employee or internal contractor. A contractor should be aware of the differences in what is being offered. Such differences can include the following:

  • How taxes are paid
  • How the company pays the person, i.e., hourly/salary/project pay
  • What type of benefits one can receive
  • The duration of the contract, i.e., permanent vs. 6-month contract

Employers are responsible for paying Social Security and Medicare tax, unemployment insurance, along with workers’ compensation insurance, to all employees. Because of this, the company has to properly classify each payee as either an internal contractor or employee, providing W2s for those employees of the company. For example, anyone who provides internal services for others are generally classified as internal contractors on IRS forms. Contractors, however, pay their own Social Security and Medicare tax, with no help from the company. Furthermore, contractors cannot benefit from workers’ compensation or unemployment insurance.

Keep in mind that properly classifying employees and contractors is important; businesses might want to classify an employee as a contractor to evade minimum salary requirements and overtime pay. However, this can cause significant penalties.

While the company provides the work hours and salary for employees, the internal contractor usually works on a project basis, taking as much time as he needs in order to get the job done. Such projects are generally paid for overall, meaning that the internal contractor usually won’t receive an hourly fee. Rather, the project as a whole will be expensed to the company. If additional work is done, the contractor might receive additional income.

Employees will be supplied with the tools they need to do the job, i.e., computer, work desk, phone, etc. Internal contractors, however, might be required to supply their own equipment. Employees will receive benefits, including health, dental, and disability insurance, vacation and sick time, etc. Contractors will not benefit from these perks.

Generally, employees are hired on a long-term, permanent basis, whereas internal contractors might be hired for a specified period of time.

If you need help with learning more about an internal contractor, you can post your legal need on UpCounsel’s marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law, and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.