Independent Contractor Agreements
As your business or nonprofit begins to grow, you’ll likely start thinking about hiring workers. Many small businesses and nonprofits try to hire their first staff as independent contractors rather than W-2 employees. But this can be a huge mistake if not done right!
What is an Independent Contractor?
The IRS considers a worker 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.” The bottom line is that an independent contractor must be “independent.” If you are telling a worker what to do, when to do it, where to do it, and how to do it, they’re not an independent contractor. They’re an employee. Even if the worker has some level of discretion (as most professionals do in this day and age), the key is whether or not you as the employer have the legal right to control what is being done and how it’s being done. In other words, are you paying the worker to accomplish a result, or are you paying the worker to perform a list of duties and responsibilities)?
So what is the difference between an employee and an independent contractor?
When you hire an employee, you control not only what the worker will be doing, but also how they will do it. But when you hire an independent contractor, you only have the right to control or direct the end results of their work. In other words, are you paying the worker to perform a list of duties and responsibilities (an employee), or are you paying them to accomplish a result (an independent contractor)? Unfortunately, like most areas of law, the answer to the question “Can I hire this particular worker as an independent contractor?” is “It depends on the specific facts of your situation.” There are a number of factors that need to be considered when making this decision.
Won’t hiring employees cost my small business or nonprofit more money?
Often, our small business and nonprofit clients are hesitant to classify their workers as employees because of the additional expenses that come with hiring employees:
While it’s difficult to estimate how much it will cost if you hire an employee vs. a contractor, you can “guestimate” that an employee will cost you 25-30% more than their hourly rate or salary when you take into account these additional costs. However, because independent contractors must pay self-employment taxes and are typically responsible for the expenses associated with running and marketing their own business, your contractor might expect to be paid more than your employee’s hourly rate or salary.
Why not just make everyone an independent contractor?
The bottom line is that many state agencies, not to mention, the IRS are cracking down on the use of independent contractors because, to be frank, tax revenue is at stake. Whether or not a worker is an employee versus an independent contractor is a legal question, and the penalties for misclassifying workers can be steep:
Do I need a contract to hire an independent contractor?
One of the factors that the law considers when determining whether a worker is an employee or an independent contractor is whether there was a written agreement that identified the worker as an independent contractor. So if your business or nonprofit hires 1099s, then yes, you should have a written contract with those workers (or preferably with their business entity).
What should be in my independent contractor agreements?
An independent contractor agreement is a business contract that spells out what the independent contractor must do, how and when they will be paid, and (if properly drafted) provides other details that justifies classifying the worker as an independent contractor rather than an employee. For example, well-drafted independent contractor agreements often emphasize that the company hiring the contractor is only interested in the end results and not how the contractor reaches those results. The contract will often point out that the contractor is responsible for providing their own tools and equipment. Or it will remind the contractor that the company will not be paying taxes or providing insurance for the contractor.
Our business attorneys see lots of poorly drafted independent contractor agreements, especially internet form templates, that don’t properly protect your business interests. (On the other hand, if you are an independent contractor, many of these bad contracts don’t protect your ability to get paid or protect the intellectual property you create.) A good contract is clear about what the independent contractor must do to get paid and when payment will be made. It should also be clear about what happens if the independent contractor doesn’t finish the job or does a poor job.
Bad template agreements also make blanket assumptions about confidentiality and work product that often don’t make sense when you really think about your particular situation. Rather than sticking to internet boilerplate language, our business attorneys take the time to help you identify confidential business information and unique deliverables and point out the best ways to protect that information.
Read more about Bad Contracts: Red Flags to Watch For
Who do I need to issue a 1099 to?
Every January, we get questions from current and former clients about who they should issue 1099 statements to and what to do if a contractor refuses to provide their W-9.
Form 1099 should be issued to each person that your business paid more than $600 during the year. However, there are several exceptions to this general rule:
The responsibility for obtaining your contractor’s tax ID number and timely issuing and filing Form-1099 is on you, not your contractor. For this reason, obtaining a signed W-9 should be required by your independent contractor agreements, and payment to any contractor should be contingent upon receiving the W-9. But if you have missed this important step and your contractor refuses to provide their tax ID number or W-9, then you should still file the 1099 with the IRS, noting that the contractor failed or refused to provide their tax ID number. Remember, the IRS can penalize both you and your contractor for failing to timely file Form 1099 and failing to provide the tax ID number.