What You Need to Know About Independent Contractors

by / ⠀Entrepreneurship Startup Advice / April 6, 2014

independent contractor

Businesses often prefer using the services of independent contractors (sometimes also called “subcontractors” or “freelancers”) rather than employees.

Independent contractors are usually a better deal for businesses.  With independent contractors, businesses do not have to pay the required employer contributions to Social Security and Medicare, the burden of which is shifted to the independent contractor through the so-called “self-employment” tax.  Businesses also do not have to worry about tax withholdings—that is the independent contractor’s responsibility too.  By using independent contractors instead of employees, businesses can often avoid workers’ compensation and unemployment insurance requirements for those individuals, as well other labor law requirements such as mandatory lunch breaks.

So, should you just treat everyone who performs services for your business as an independent contractor?  No, only certain workers can legally be treated as independent contractors.  Treating someone as an independent contractor when he/she is legally considered an employee can have terrible consequences—fines, penalties, unexpected taxes, interest and other liabilities.

Is Your Worker an Employee or an Independent Contractor?

Unfortunately, there is not a simple test—and various government agencies have slightly different criteria for determining whether your worker is an employee or an independent contractor.

The Internal Revenue Service (IRS) website explains its standard as follows:  “The general rule is that an individual is an independent contractor if the payer has the right to control or direct only the result of the work and not what will be done and how it will be done.”

Some factors that may be examined include:

–         who controls when, where, and how the work is done

–         how a worker is paid

–         whether expenses are reimbursed

–         who provides tools and supplies

–         whether the worker is free to seek out other business opportunities

–         whether the worker advertises and/or maintains a visible business location

–         the permanency of the relationship

–         degree of independence

–         the extent to which the worker’s services are integral to the company’s business; and

–         whether the worker receives traditional employee benefits, such as pension, health insurance or vacation pay.

However, any information related to the degree of control and independence is potentially relevant.  If you are unsure whether you are dealing with an employee or an independent contractor, you should seek the advice of an attorney because the consequences of misclassifying the worker are so significant.

It is good to define the relationship in writing.  That might make some difference in a close case.  But if an employer-employee relationship exists, it doesn’t matter what you call it—it’s still an employer-employee relationship.

Federal Tax Forms

You should have the independent contractor complete a Form W-9, Request for Taxpayer Identification Number and Certification, at the time of engagement.

If you pay an independent contractor $600 or more during a year, you will need to complete a Form 1099-MISC, and provide a copy to the independent contractor by January 31 of the year following payment, then also provide a copy to the IRS.

Copies of and instructions for these forms can be obtained from the IRS.

Written Agreements

Written agreements with independent contractors are not typically mandated by law.  However, it is smart to have written agreements with your independent contractors.  Written agreements allow you to define important terms of the business relationship.  Examples include:  payment terms, deliverables schedule, ownership of work product, insurance, security requirements, standard of care, non-disclosure covenants, and remedies for breach.  Of course, there are many more terms that could be, and often are, included.  Without a written agreement, you are likely to have difficulty in attempting to enforce your rights.

You want to be in control of the contract drafting process if at all possible.  You want to set forth your desired terms—your “standard terms”, if you have a contract that you use repeatedly.  You can always negotiate if you want, but you should be the one to suggest the starting point.  Including reasonable terms in your agreement is the best way to avoid resistance from the independent contractor.

You should have any written agreement prepared by—or at least reviewed by—an attorney.  Contract law is complicated, and sometimes words may have legal meanings that differ from what you might think.  Business-focused lawyers have the training and experience to protect your rights, negotiate terms that are favorable for you, and ensure that the agreement actually means what you think it means.

If your business often engages independent contractors under similar terms, it may be possible for your attorney to provide a quality contract with standardized legal “fine print”, but allowing you to fill in the business terms that change in each deal, such as price, deadlines, and project descriptions.  That way, you only have to pay your attorney for preparing one contract—even if use it 4, 5 or even 100 times.

Joshua Korman is an attorney from Buffalo, NY, who focuses on business law and estate planning.  Information about his law practice and other articles by him are available on his law firm’s website: www.brodykorman.com.

Image Credit: Shutterstock.com

About The Author

Matt Wilson

Matt Wilson is Co-Founder of Under30Experiences, a travel company for young people ages 21-35. He is the original Co-founder of Under30CEO (Acquired 2016). Matt is the Host of the Live Different Podcast and has 50+ Five Star iTunes Ratings on Health, Fitness, Business and Travel. He brings a unique, uncensored approach to his interviews and writing. His work is published on Under30CEO.com, Forbes, Inc. Magazine, Huffington Post, Reuters, and many others. Matt hosts yoga and fitness retreats in his free time and buys all his food from an organic farm in the jungle of Costa Rica where he lives. He is a shareholder of the Green Bay Packers.