Independent contractors are a great way for employers to handle short-term projects without hiring a full-time employee.
Independent contracting within the technology industry has exploded over the past 10 years and is showing signs of exponential growth. As such, there are important points that any independent contractor or company using an independent contractor should keep in mind when entering into an independent contractor relationship.
1. The Independent Contractor’s Legal Entity
- What is it? This is a greater concern for an independent contractor. The tax savings of incorporating as an S-Corp can be significant, and it’s well worth the extra paper work. (Learn more about types of corporation entities here.)
- When to use? It is generally recommended that an independent contractor form some sort of legal entity instead of operating as a sole proprietor. If anything, this makes your services appear more legitimate.
- What to do? See Guide To Forming A California Corporation for step by step instructions on how to do this. Make sure to seek out an attorney to help you with this process. Please consult a tax advisor for full instructions on how to reap the maximum tax benefits.
2. Determine if an Independent Contracting Relationship Exists
- What is it? This is more of a concern for the company using the independent contractor, as there are significant penalties for misclassifying someone as an independent contractor vs an employee. Employee audits are becoming increasingly frequent, so this is no small matter – even for a startup (just ask Groupon who got nailed with an employee audit in 2010). Also check out this video on the Hidden Dangers of Independent Contractors.
- When to Use? Always!
- What to do? The IRS has laid out guidelines for determining whether someone would be classified as an independent contractor or an employee. Silicon Valley Employment attorney Gary M. Gansle has also laid out some important guidelines for making this the independent contractor determination.
3. Non-Disclosure Agreement (NDA)
- What is it? A non-disclosure agreement protects information which is disclosed to one or more parties. It legal binds the receiver of information from improperly disclosing or using the information without the consent of the discloser.
- When to use? Prior to a formal consulting relationship being established. For obvious reasons, sensitive information must pass from the company to the independent contractor in order for the contractor to create a proposal or assess a project. An independent contractor or consulting agreement signed upon consummation of the relationship will typically contain additional confidentiality language.
- What to do? Typically the independent contractor will sign a one-way non-disclosure agreement with the company.
- Free Legal Document: One Way Non-Disclosure Agreement
4. Consulting/Independent Contractor Agreement
- What is it? The primary/master agreement which manages the relationship between a company and an independent contractor. Among other things, the agreement should establish 1) an independent contracting relationship, 2) ownership rights in any work product, and 3) confidentiality.
- When to use? Always.
- What to do? Create a Consulting Agreement. Make sure to have your lawyer review the agreement to ensure any language that eludes to an employment relationship is left out. Have the contractor and company sign the agreement.
- Sample Document: Independent Contractor Agreement
5. Statement Of Work (SOW)
- What is it? The document which describes the work to be performed under the consulting relationship. Typically, this agreement will lay out the project deliverables, milestones and payment terms. A Statement of Work is a part of the master Consulting Agreement – most often as an attachement. Depending on how the Consulting Agreement is written, the parties can execute numerous Statements of Work in an on going independent contractor relationship but the relationship is still governed by the original master Independent Contractor Agreement (like the example above).
- When to use? Found in most consulting relationships.
- What to do? The Statement of Work is the most negotiated piece of the consulting relationship. Make sure to make the Statement of Work as detailed as you can to set the appropriate expectations.
- Sample Document: Attachment to Consulting (Independent Contractor) Agreement.
6. Optional – Amendment to Statement of Work
- What is it? The Statement of Work is changed often in an independent contractor relationship while leaving the Master Independent Contractor Agreement untouched. The parties may wish to amend the Statement of Work if the job, materials or payment expectations have changed. It is totally up to the parties to make these changes.
- When to use? Optional if the parties need to amend the statement of work.
- What to do? Complete an Amendment to Statement of Work and include a new version of the Statement of Work which you will attached to the Amendment. Have both parties agree and sign the Amendment.
- Example Document: Amendment to Statement of Work
7. Optional – Issue Stock or Grant Options To Independent Contractor
- What is it? The Company may pay an independent contractor in stock options of the company. Typically they would be a Non-Statutory Stock Option vs. Incentive Stock Option.
- When to use? If you plan to grant stock or options to the independent contractor then this should always be done.
- What to do? We will publish soon the proper procedures for issuing stock and granting options. It should be noted that any granted options or issued stock to an independent contractor must be approved by the Board, and should be done AFTER the independent contractor has begun working for the company. This can be done in Board Minutes. The company must first have an stock option plan in place first. Generally, once the options have been approved, the independent contractor and the company will then enter into an agreement for the agreed upon equity (which are discussed in the SOW of the independent contractor agreement).
- What is it? In many states, any business or government entity that is required to file a federal Form 1099-MISC for services received from an independent contractor is required to report specific independent contractor information to the state’s employment department. In California, employers will report such independent contractors with the Employment Development Department (EDD).
- When to use? California requires a business to report using an independent contractor if: 1) You are required to file a Form 1099-MISC for the services performed by the independent contractor, 2) You pay the independent contractor $600 or more OR enter into a contract for $600 or more (this includes stock options), AND 3) The independent contractor is an individual or sole proprietorship. So all three of these conditions must be present for the requirement to arise.
- What to do? Check to see if you have to report the independent contractor. In California, independent contractors can be reported through the California e-business services.