Freelancer vs. Employee: Hiring the Legal Way

Your business is scaling and you are hoping to hire some help for your business. There are a few considerations to keep in mind – one wrong move could mean tax audits, penalties, fines or worse, lawsuits.

Following is a quick guide on how to avoid the trap of misclassifying the people you hire.

Table of Contents

1. What is the difference?
2. Current Employment laws – U.S and Canada
3. Which should you choose (and when)?
4. 3 Common pitfalls to avoid
5. Actionable Insight

What is the difference?

Take a look at the following table:

Feature	Freelancer/ Independent Contractor	Employee
Control	Has the ability to set their own hours and choose how to work.	The business controls schedules and tasks to a considerable degree.
Tools	Will use their own equipment in majority of cases.	Everything has to be provided by the employer.
Taxes	Handles their own taxes.	Employer/Business has to deduct and remit taxes and do all that the necessary calculations.
Risk to Profit	Depending upon the project, can profit or lose from it.	Has a steady wage and employment.
Legal Obligations	Very few legal protections as a freelancer. No vacations, no employment insurance, etc.	Business has to ensure that the employee is entitled to benefits and protections as per the labor laws.

Current Employment laws – U.S and Canada

A good benchmark are the regulatory frameworks and labors laws in Canada and US, where the consequences of getting it wrong can be quite steep for the business.

1. Canada: In Canada, the Canada Revenue Agency (CRA) determines whether a worker is an employee or a contractor based on key factors such as how much control the business has over the work, who provides the tools and equipment, the worker’s chance of profit or risk of loss, and the parties’ original intent.

For a detailed guide, check out this CRA link.

Penalties: In the event the business misclassifies the worker, then you could owe back taxes, Employment Insurance, CPP and other penalties.

“In Canada, the legal standard is higher—you need to justify an independent contractor relationship with solid proof.” – Canada Revenue Agency

2. USA: In United States of America, the Internal Revenue Service (IRS) evaluates various behavioral control, financial control and the nature of the initial relationship that was formed, in order to judge whether the worker is an employee or a contractor.

For more information on the factors, check out this IRS Guide.

Penalties: In the event the business misclassifies the worker, you could owe back payments, Medicare, Social Security can your business can even face lawsuits.

“Just calling someone a freelancer doesn’t make it true. Courts look at how the work is done.” – Internal Revenue Services (IRS)

In summary, Canada uses a 4 factor test: Control, tools, chance of profit/loss and integration.

US uses a 3 part test: behavioural, financial and the type of relationship.

Which should you choose (and when)?

Now comes the difficult question – who should you hire and when? What are some things you should think about before making a decision?

Let’s break it down by scenario:

• When to hire a Contractor/ Freelancer:
• If the project you have is on a short term basis, such as redesigning your website, coding specific parts, etc.
• The project does not require your constant oversight and the freelancer can complete the project with little instructions.
• You are testing out a new market and looking for some flexibility.
• You are unable to afford to keep someone on a payroll taxes or benefits yet.

Example: You recently started a small ecommerce business. You hire a freelancer to manage your social media and grow your audience over the course of 4 months. They will use their own tools, work on their own schedules and invoice you monthly based on the work they have done.

Caution: A contractor relationship is governed primarily by a contract, so it’s essential to clearly outline expectations and deliverables in writing. There is also a growing trend of having a written contract and a Smart Contract.

• When to hire an Employee:
• The work that needs to be done is core to your business and would be required for a longer period of time.
• You would like to have full control over the way the work is done and how it is done.
• You would require the worker to be available regularly in order to perform their duties.
• You are building a long term team.

Example: You have built a mobile app and it requires daily customer support. That means consistent hours and performance tracking. Hence, an employee is the answer.

Caution: Hiring an employee is often more expensive in the long run than working with a contractor. It also comes with added responsibilities, including compliance with labor laws and employment regulations.

3 Common pitfalls to avoid

We have seen well-meaning founders and employers often trip over worker classification. Following are a few common mistakes that can end up costing you big time:

1. Mistake 1: “A contract was signed which says that the worker is a freelancer/ contractor. So our business is safe.”

It certainly feels safe to have a contract that labels your worker as a freelancer, but that label in the contract will not protect you if the reality of the relationship is otherwise. Courts and tax agencies DO NOT CARE WHAT THE PAPERWORK SAYS if the reality looks like an employer-employee setup as per the factor-test.

For example, if you assign them daily tasks, you control how they set their schedules, you provide any or all the tools they have to use, then clearly the reality of this relationship is that of an employer or employee.

2. Mistake 2: “Contractors and Freelancers are cheaper, so let’s just hire them and work that way.”

As we mentioned above, freelancers are certainly cheaper in the longer run, but if you misclassify your worker and trat them like an employee, you risk heavy penalties, lawsuits and even back payments. The idea here should be to use contractors strategically; whenever work needs to be done that requires minimum oversight, project based outcomes and true independence, only then must a freelancer be chosen. Clearly this is a very case by case basis so proper evaluation of the type of work needs to be done before choosing.

3. Mistake 3: “We will use the same approach in Canada and US”

North American laws certainly sound similar, but there are quite different. They apply different tests, offer different forms of protections and also carry starkly different penalties and consequences for misclassification. What passes as a contractor in one country might not fly in another. And this holds true for the entirety of the world. Treat each country’s laws independently. Research local legal frameworks and standards or consult cross border HR/Legal experts before hiring someone internationally.

Actionable Insight

Deciding between a freelancer/ contractor or an employee is not just a budget call, it is also a legal and strategic decision.

Any misstep here does not just impact your payroll, it could also open the door to tax penalties, compliance issues or even lawsuits. And if you are a younger business, every dollar and decision counts.

Here is a pre-hiring checklist that can be helpful:

1. Understand your country’s classification rules: Each country has its own criteria for determining whether a worker is an employee or an independent contractor. In Canada, the CRA looks at control, tools, financial risk, and intent. In the U.S., the IRS and Department of Labor focus on behavioral and financial control, and the nature of the relationship.

2. Assess how the work will be done (not just what’s in the contract): Even if someone signs a contract as a “freelancer,” courts and tax agencies care more about how the job is carried out. Are you setting their hours? Are they using your tools or systems? Are they working for you exclusively?

3. Put it in writing: Regardless of classification, a clear, detailed contract is a must. Outline the scope of work, payment terms, intellectual property ownership, timelines, and termination clauses.

Pro tip: For contractors, be sure to include a clause stating they’re responsible for their own taxes and insurance—but remember, that alone won’t protect you if the working relationship tells a different story.

4. Seek expert guidance: This isn’t an area where you want to DIY based on Google or ChatGPT advice. Consult a legal or HR professional—especially if you’re hiring across borders, the work is ongoing or core to your business or you’re unsure about how much control you’ll have over the worker’s day-to-day.

A short legal consult can save you tens of thousands down the road—and help you avoid the stress of dealing with audits, penalties, or legal claims.

Book a free 15-minute consultation with our legal team—we’ll help you hire the right way, from day one.