Hiring Independent Contractors: How to Hire in 7 Easy StepsStartup Law ResourcesEmployment Law, Human Resources
Hiring independent contractors is complex as they may actually be classified as employees by the IRS. Read our 7 step guide so that you can comply with the law.5 min read
With the rise of companies such as Uber and Lyft, the attempt to define the workplace role of the independent contractor is gaining serious traction. How can you be sure whether your next employee should be an independent contractor, and what steps can you take to ensure governmental compliance?
1. Understand What an Independent Contractor Is
To understand what an independent contractor is, think about when you hire plumber. When you need your toilet fixed, you are calling an independent contractor. You don’t tell your plumber what to wear or when you when he can come to work, and you certainly don’t provide vacation benefits or sick time. Independent contractors provide services to you or your business on a project basis. According to the SBA, independent contractors:
a. Have a business name;
b. Possess a business checking account;
c. Advertise their services;
d. May have their own employees;
e. Have a business address;
f. Will send you a work invoice;
g. Have other clients;
h. Have their own tools and computers; and
i. Keep actual business records.
In other words, they are independent of your business and self-employed. You are not directing or controlling the type, manner, and timing of the work. They use their own equipment for their work, they may also work for others, and they send you invoices for their work. The IRS considers several factors in weighing whether a worker is an employee or an independent contractor. A helpful guide to understanding these factors are available here.
2. Understand Your Needs
Many startups hire independent contractors because of the common issues associated with hiring employees. There are the costs of benefits, paid time off, office space, equipment, unemployment compensation insurance, and worker’s compensation insurance. Employers have to comply with state and federal law and have specific employment verification and reporting obligations. Employers have to withhold taxes and send these funds to the government. These expenses and costs of compliance can be substantial, and hiring independent contractors can provide flexibility for the company’s then-current needs. Independent contractors bring already-existing specialized skills that save hiring and training costs and time.
However, there are also drawbacks to hiring an independent contractor. You have less control over their work because independent contractors have the autonomy to determine how best to do the project they were hired for. The quality of the work of independent contractors may be inconsistent. The scope of the work may be limited by the contract you enter into with the independent contractor. You should understand the needs for your company when determining whether an independent contractor is right for you.
3. Do It Right
When the corner restaurant hires a line cook, the employer/employee agreement is often verbal. Both parties may agree on working hours, when to take a lunch, and a start date with just a handshake. You need to be more careful with independent contractors. You should enter into an Independent Contractor Agreement, which is usually prepared by a startup lawyer, with the following provisions at a minimum:
a. Your company information is strictly confidential;
b. You are not withholding any taxes;
c. You are not providing any benefits;
d. The contractor cannot solicit business from your clients/customers;
e. You can terminate the relationship for any reason; and
f. You have ownership of the independent contractor’s efforts for the project.
You can also strengthen your independent contractor relationship status by keeping clear records. When you advertise for independent contractors, don’t use the phrases “wages” or “salary.” Keep on file any business cards or ads that you used to find the independent contractor. Always ask for an invoice or statement for the work performed before payment. Any payments to the independent contractor should be on a fixed, per project basis, and explicitly outlined in the invoice. Do not reimburse the independent contractor for any expenses as they should be part of the calculated project fees. If possible, make checks payable to the independent contractor’s company rather than to an individual name.
4. Comply with IRS Rules
While you don’t need to withhold any taxes from an independent contractor’s paycheck or pay benefits, you do need to tell the IRS if you paid your contractor more than $600 during the previous calendar year. Have your independent contractors fill out a Form 1099. Copies of the completed form should be sent to the contractor as well as the IRS. The Employer Identification Number (EIN) on the W-9 is what the IRS uses to track business entities.
5. Be Aware of Work for Hire Issues
Copyright law states that whoever creates a work owns the copyright for it. if you have employees creating the work, this right can revert to you as their employer. You should make sure that it is clear that you own the work that the independent contractor produces. For example, if the independent contractor creates a company product manual, you should make sure it’s clear that you own the rights to that manual. To ensure that this happens, explicitly outline this your rights to the product created in the Independent Contractor Agreement.
6. Know Your Risk vs. Reward
Just because you classify your new hire as an independent contractor, doesn’t mean that state and federal agencies will do the same. Hiring an independent contractor increases changes of government audits, which can be time-consuming and intrusive to your business. Government agencies may claim that you have incorrectly classified employees as independent contractors. If this happens:
a. You may be fined;
b. You may have to pay back taxes;
c. You may have to pay overtime in arrears; and
d. You might have to provide insurance benefits.
If you have true independent contractor relationships with your workers, you should be okay, but be careful, as contractor and employee lines can sometimes blur. For example, this scenario may occur:
You hire Joan to redo your website. She works at home for a few weeks and provides you with the finished product. It’s great, but you have some issues with your email server, and Joan comes into the office to fix them. Then, your receptionist suddenly quits, and Joan says she’ll be happy to help out.
Soon, Joan is working eight hours at your office every day and performing the duties of the regular employee she replaced. If you are still paying her as an independent contractor and the federal or state Labor Department audits you, you may have a big problem.
7. Find Your Rock Star
While you may already know exactly who your next independent contractor will be, here are some additional resources to find independent contractors:
b. University job boards;
c. Business incubators;
d. Traditional job websites such as Indeed.com; and
e. Your network of attorneys, CPAs and friends.
Following these guidelines will give you a great start to navigating the independent contractor hiring landscape. If you need help with this process or with drafting a solid Independent Contractor Agreement, post your legal need on UpCounsel's marketplace.
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