Hiring workers is an important step for a business. A business owner is faced with a chicken-and-egg dilemma: Is it better to hire employees anticipating that the business will grow, or wait until the business has grown and then hire employees? When a business is starting out, a full-time employee may not be needed. Business owners may instead consider hiring an independent contractor to complete smaller, discrete tasks or to work on specific projects.
Hiring independent contractors instead of employees allows business owners to outsource certain tasks, such as managed IT services or bookkeeping, without the expense and administrative burden of setting up W-2 withholdings, benefits, and payments for Medicare, Social Security, unemployment compensation insurance, and worker's compensation insurance. Additionally, hiring independent contractors increases a business's flexibility: Employers can end their relationship with contractors more easily than with staff employees, and they are not obligated to pay contractors when there is no work.
Before hiring your first independent contractor, make sure you are fully prepared. While this list is not exhaustive, it will provide you with some important background information before you hire a contractor.
- Understand the factors relevant to a worker being legally classified as an independent contractor. Often, independent contractors are business owners who are in a profession or trade that offers services to the public. According to the Internal Revenue Service (IRS), a worker is an independent contractor for a business if the business owner can only control or dictate the type of work or result of the work to be completed and not the manner in which the work is completed.
A few questions can help you determine whether the person you want to hire is likely to be classified as an independent contractor rather than an employee. First, will you be hiring this person for a temporary project or projects? Second, will the worker determine where and when to conduct the work that will be done for you? Third, will this person use his or her own technology or equipment to complete the work? Finally, will the worker be paid on a flat-fee basis or hourly?
Generally, the more control the worker has over the manner in which the work is performed, the more likely the worker is to be classified as an independent contractor. The more the employer dictates the time, place, and manner in which the work is done, the more likely the worker will be legally classified as an employee. It is very important to make sure you classify your workers correctly as independent contractors or employees. You risk paying significant fines and penalties if you misclassify your workers.
- Verify credentials. As with any new hire, make sure to request and review the prospective worker's resume and references before the worker begins work. Review the worker's resume, ask questions, and make sure the person has the qualifications and experience necessary to complete projects for your business. Also, call the references. If the worker owns a business, check the Better Business Bureau as well as online reviews. Make sure there are no complaints filed against the worker or any allegations that would make hiring the worker inadvisable.
In some instances, it may be appropriate to conduct background checks. However, you should do this primarily when a person's criminal history is relevant to the work at hand. Ban the Box legislation is aimed at preventing discrimination in the hiring of people with arrest records or convictions. However, some states require individuals working with children and the elderly to undergo a background check.
- Establish an accurate payment s Business owners should ask the independent contractor to submit detailed invoices for work performed. A contractor should not be paid prior to receipt and review of an invoice. Paying a contractor without receiving an invoice resembles payment of wages to an employee. In addition, a business owner should not withhold any taxes from the contractor's payment. The contractor is responsible for paying the contractor's income taxes, as well as Social Security and Medicare taxes. You will need to keep track of payments made to the contractor and report them to the IRS.
In addition to taking the steps outlined above, ensure that you have the following essential documents in place:
- Tax forms. The independent contractor will complete a Form W-9 with the contractor's Tax Identification Number, and you will complete the corresponding Form 1099-NEC to report payments made to the contractor to the IRS. Check with your CPA to ensure that you have complied with the state and federal requirements.
- Independent contractor. Every employee should sign an employment agreement with your business. Similarly, every independent contractor should sign a contract that defines the work to be performed, the nature of the relationship (independent contractor, not employee), termination provisions, and payment terms.
- Confidentiality. Your business's success stems from its unique business strategies and trade secrets. When an independent contractor begins working with you, the contractor may become familiar with these strategies and secrets. Before the contractor begins any work for your business, you should ensure that the contractor has signed a nondisclosure agreement prohibiting disclosure of this confidential information to your competitors or anyone else without your permission.
- Agreement not to compete. Before a contractor begins work, you may also want the contractor to sign an agreement not to compete with you after the working relationship ends. A noncompetition agreement sets out terms to prohibit the contractor from competing with you in a certain geographic area and for a specified time after the relationship with your business has ended. Likewise, an agreement not to solicit is designed to prevent the contractor from taking your customers or employees with him or her when the contractor leaves. The contractor should sign a nonsolicitation agreement prior to beginning work.
Keep all records and agreements on file for each of your independent contractors. While you may not be required to turn over your files, if the IRS audits your business, having these documents will help confirm the nature of the independent contractor's relationship with your business. This list is not exhaustive for every type of business, but we have a team of lawyers ready to help you prepare these documents and any others that are specific to your business.