Independent Contractors and What You Need to Know Before Hiring One
When you run a business, not everyone who does work for your company is considered an employee. Some may be considered independent contractors. For example, maybe you’ve outsourced the design of your website to an external web designer, or you’ve hired a freelance copywriter to create some marketing brochures for you. These workers aren’t considered your employees—they’re independent contractors.
This is more than just a difference in title—different tax authorities have very specific requirements someone must meet to be considered an independent contractor. In fact, the independent contractor classification is often scrutinized, so you don’t want to get this wrong.
The IRS has a general rule about who qualifies as an independent contractor. Its definition is: “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.”
In practice, independent contractors generally have flexible work hours, options to work from home, and set their own rate. They’re also considered self-employed, which means they’re responsible for paying self-employment tax, and the company they do work for does not need to provide them with benefits.
The IRS isn’t the only organization that defines who qualifies as an independent contractor and who qualifies as an employee. Many states have adopted another set of more stringent requirements to be considered an independent contractor, known as the ABC test. This test has three separate criteria a person must meet in order to qualify as an independent contractor, rather than an employee:
- The worker is free from the employer’s control or direction in performing the work
- The work takes place outside the company’s usual course of business, and off-site of the business
- Customarily, the worker is engaged in an independent trade, occupation, profession, or business
Both the IRS requirements and any state-specific requirements are important to pay attention to because improperly classifying an employee as an independent contractor could saddle you with some big fines.
Pros to Hiring an Independent Contractor
There are a lot of benefits to hiring a contractor that might be helpful to business owners, including:
When you hire an employee, you have expenses that extend beyond their hourly rate. It’s also your responsibility to pay for:
- Office space for them to work from
- Equipment needed to perform their tasks (i.e., computers and software)
- Benefits such as health insurance and paid time off
- Any additional taxes like FICA taxes
When you hire a contractor, you’re only responsible for paying their fee. You don’t need to pay for their benefits and they’re required to cover their own taxes.
You might find that contractors are paid a higher hourly rate than employees, but because you’re not paying these additional benefits, you’ll usually end up saving more money overall.
If your business has a lot of varied needs—say you need someone to do social media marketing, copywriting, and website updates—it can be difficult to find one employee that can handle all of those tasks well. Instead of having to hire one person to do all three jobs, or hire three separate people to handle these varied tasks, you can work with independent contractors.
This gives you access to everything from high-level network administration to top-tier copywriting.
You can also use contractors to manage increases in your business workload. Beyond having more skills at your disposal, contractors will enable your business to respond quickly to unexpected surges in business.
Hiring independent contractors might mean that you come under additional scrutiny. In the US, it’s important to note that using independent contractors has led to an increased risk of audit.
The IRS wants to ensure that companies haven’t misclassified workers who should be employees as independent contractors in an effort to save money on income taxes. With an independent contractor, business owners don’t have to provide benefits, pay unemployment insurance, withhold income taxes, or pay Social Security and Medicare taxes.
TURNOVER AND LACK OF LOYALTY
You’re not going to build a loyal workforce with independent contractors. They come and go as needed. Contractors are drawn to this type of work largely because it gives them greater control over who they work with. Additionally, most businesses hire contractors for short-term jobs, which makes it difficult to cultivate loyalty.
Relying too heavily on contractors means dealing with a higher turnover rate than employees. You also risk losing your contractor without notice if a higher paying project comes along.
What Documents Are Needed When Hiring a Contractor?
Hiring a contractor means a lot less paperwork than hiring an employee. But there are still a few things you’ll want to collect:
- Tax information number: You’ll need to know the social security number or employer identification number
- Signed contract: Work shouldn’t be done without a contract signed by both parties in place. This helps to clear up any misunderstandings that may arise in the future. Be sure the contract covers the duration of the work, the pay, and intellectual property rights.
How to Pay an Independent Contractor
Paying a contractor is much simpler than paying an employee. That’s because you’re generally not required to withhold.
When it’s time to pay your independent contractor, you can do so via whatever payment method is most convenient for you: Check or direct deposit.
You’ll want to be sure you file any forms at the end of the year with the tax agency in the country. In the US, you’ll need to file 1099 for any contractors which you’ve paid more than $600 during the year.
A Final Note
The differences between an independent contractor and an employee may seem insignificant at first glance, but tax agencies take this very seriously. Do your research and ensure you properly classify workers as either employees or independent contractors. Once you understand the differences, you’ll know what requirements you need to adhere to, and how not to end up in trouble.