The American tax code confers numerous benefits and protections on full-time employees. For instance, full-timers are not responsible for withholding their own taxes or determining the value of their financial obligations to Social Security and Medicare. In addition, full-time employees are generally eligible to receive employer-sponsored health insurance, retirement accounts, life insurance and other fringe benefits. In fact, larger employers are now required to provide their full-time employees with some form of health insurance coverage.
By contrast, part-time employees and contractors aren't entitled to receive these benefits. While generous employers are permitted to provide various types of benefits to such employees, no federal laws compel them to do so. Accordingly, hiring and retaining part-time employees and contractors is far easier and cheaper than recruiting full-time employees. Contractors and part-timers also present fewer logistical headaches. Since a firm must devote many hours to the training of each full-time employee that it hires, the opportunity cost of hiring the "wrong" employee can be significant. A new hire who quits or invites termination after a relatively short period of time may subject his or her employer to a significant financial loss.
For this reason, many low-margin employers choose to retain contractors to complete discrete projects that may not require the attention of a team of full-time employees. Even if they're paid at commensurate rates, contractors tend to be less expensive to retain. The reason for this is clear: They can't legally demand fringe benefits, paid vacation time, insurance or other perks that come with full-time status.
In fact, the allure of contract employees is strong enough to encourage some employers to bend or break the law. It's not uncommon for smaller, cash-poor companies to require "contracted" employees to work in full-time capacities. While this arrangement is not technically illegal, it may invite closer scrutiny from the IRS. Depending upon the rules that the pertinent contractors are required to follow, the IRS or Department of Labor could well deem them to be "extra-legal" full-time employees.
You shouldn't be confused about whether you're a contractor or full-time employee. If you are, you can determine your status in two different ways. First, ask your employer how your taxes are being handled. If you're required to fill out a W-9 form and withhold your own taxes, you're a contractor. Secondly, determine whether you're being paid upfront or for "hours worked." If it's the former, you're almost certainly a contractor.