Employee vs Contractor: A Simple Guide for Business Owners

When dealing with an employee vs contractor classification, the stakes for business owners and workers couldn’t be higher. 

Misclassifications can trigger costly ATO audits, leading to back payments for superannuation and workers’ compensation premiums.

For business owners, a mistake could result in paying unplanned entitlements and fines. Workers, too, need to understand their status to ensure they comply with legal and tax obligations

To help clarify, here’s a side-by-side comparison of employees and contractors, explaining the key differences and why they matter.

Legal and Administrative Requirements

One of the biggest distinctions between employees and contractors is how they are set up legally and administratively.

Employee

Employers are responsible for handling paperwork like tax file number (TFN) declarations and superannuation choice forms. Employees are also covered under the employer’s workers’ compensation insurance and receive benefits like leave accrual.

Contractor

Contractors must handle their own setup, including registering an Australian Business Number (ABN) and obtaining insurance. Businesses hiring contractors must confirm these elements to ensure compliance. Contractors do not receive employer-paid benefits like superannuation or leave entitlements, reinforcing their independent status.

If contractors are misclassified as employees, businesses could be liable for backdated workers’ compensation premiums and unpaid superannuation. This makes proper classification critical from the outset.

Control and Independence

Control is a critical factor in distinguishing employees from contractors.

  • Employees: Employers dictate how, when and where employees work. They are expected to follow schedules and use specific methods their employer sets. This level of supervision defines the traditional employee-employer relationship.
  • Contractors: Contractors have the freedom to decide how they complete their tasks. They set their own schedules, determine their work methods, and may even delegate tasks to others. This independence is a hallmark of contractor status and is carefully evaluated during ATO audits.

Employers who blur these boundaries risk having contractors reclassified as employees, potentially leading to back payments for entitlements.

Payment Structures and Billing

How workers are paid is another defining characteristic that separates employees and contractors.

Employees

Employees are usually paid hourly, weekly or through a salary arrangement. Their payment reflects the time they spend working and includes additional entitlements such as overtime pay and leave accrual.

Contractors

Contractors bill based on the value of the project they complete rather than the hours worked. For example, a contractor might quote $3,000 for a project, regardless of how many hours it takes to finish. This approach emphasises results rather than time and aligns with ATO expectations for independent contractors.

Invoices from contractors must reflect this project-based approach. 

Properly worded invoices and contractor agreements are essential to define responsibilities and avoid misclassification risks clearly.

Tools and Resources

Another clear distinction between employees and contractors lies in who provides the tools and resources.

  • Employees: Employers supply the equipment and materials needed to perform the job. This could include computers, software or uniforms. Employees do not bear the costs of maintaining or replacing these tools.
  • Contractors: Contractors use their own tools and equipment. These costs are often factored into their project fees. For example, a contractor in a trade might include expenses for specialised tools when preparing a quote.

Employers who provide contractors with tools must document these arrangements carefully to avoid misclassification risks.

Responsibility for Errors

Employees and contractors handle mistakes in their work differently.

Employees

Employers typically absorb the costs of mistakes made by employees. Employees are not held personally responsible for additional time or resources required to fix an error.

Contractors

Contractors take full responsibility for their work. If a mistake occurs, they must rectify it at their own expense. This accountability further differentiates contractors as independent business operators.

Risks of Misclassification As Employee or Contractor

Misclassifying workers as contractors when they function more like employees exposes businesses to significant risks.

ATO audits often focus on:

  1. Payment Structures: Contractors should bill per project, not by hours. Hourly payments may indicate an employee arrangement.
  2. Control Over Work: Contractors who follow set hours or receive detailed instructions may be deemed employees.
  3. Entitlements: Businesses could face hefty backdated liabilities if contractors are treated like employees but denied superannuation or other benefits.

Additionally, the ATO examines whether contractors meet key criteria, such as having an ABN, insurance and true independence over their work. 

Documentation like contractor agreements and invoices is crucial for demonstrating compliance.

What Workers Should Know

For workers deciding between staying as employees or registering as contractors, the choice goes beyond work preferences.

  • Employees: Employees benefit from structured arrangements, including predictable pay, leave entitlements and employer-provided tools. However, they are subject to the control of their employer, including set schedules and work methods.
  • Contractors: Contractors operate their own businesses. This comes with flexibility and responsibilities, such as obtaining an ABN, insurance and managing their own tools and expenses. If you consider becoming a contractor, you may want to evaluate your readiness for these responsibilities.

Conclusion

Understanding employee vs contractor classification differences is essential for avoiding costly mistakes. 

Employers must carefully evaluate how they engage workers, ensuring compliance with ATO requirements to avoid audits and penalties. 

On the other hand, contractors need to set up their businesses properly and demonstrate their independence through clear invoicing, work methods and responsibilities.

Properly classifying workers doesn’t just protect against fines—it builds trust and ensures smooth working relationships.

Book a consultation with MYC Partners to ensure your worker classifications and arrangements comply with ATO guidelines.

Want to Simplify Your Tax Prep?

Our FREE guide equips you with pro tips and checklists for both personal and business returns. Download now!

About The Author

Scroll to Top