In today’s workplace climate, more companies are looking to hire independent contractors and freelancers to complement their staff of full-time employees. A study by the U.S. Bureau of Labor Statistics and academic research shows that between 6.9 percent and 9.6 percent of all workers are independent contractors, which constitutes about 10 to 15 million workers. These workers play a much-needed role for companies that don’t have the desire or funds to fill a full-time position. Although an independent contractor isn’t an “employee” by technical standards, consideration still needs to be taken when hiring one.
What is an Independent Contractor?
Simply put, independent contractors or 1099 contractors are hired by a client for a specific task. The independent contractors control how and when they perform the task. Some examples of independent contractors include plumbers, writers, photographers and consultants. According to the Washington Center for Equitable Growth, independent contractors run their own professional operations, contract with many different families or businesses, negotiate mutually agreeable contract terms, are free to complete their work without control by their customers outside of those contracts, and are not integral to their customers’ business models.
Benefits of Hiring Independent Contractors
There are several reasons a company might employ a 1099 contractor.
- Hiring Is Dependent on Workload. Hiring an independent contractor gives companies the flexibility to manage their payroll or work hours based on the amount of work they currently have. For example, companies only hire help when the work is available, so they never have to pay employees to “stand around”.
- Not Having to Pay Taxes or Health Benefits. Since a 1099 contract worker is not an employee, the employer isn’t required to pay Social Security and Medicare taxes, unemployment or workers comp or to provide benefits. Most states permit an independent contractor to be eligible for workers comp benefits by paying separately into the state workers compensation fund, according to Workplace Fairness.
- Less All-Around Paperwork. Even though some paperwork is required to hire an independent contractor (see more on that below), it is considerably less compared to hiring a regular employee. For example, hiring paperwork, reports and payments to the IRS are seriously diminished. And, if you do terminate the relationship, the process isn’t encumbered by paperwork requirements and other potential problems that go with firing an employee, according to the Balance Small Business.
Classifying an IC Properly
To take advantage of all the benefits an independent contractor can provide for your business, he or she must be classified correctly in your company records. According to SHRM, your employees’ status triggers several obligations under federal and state laws, yet these same obligations don’t apply to independent contractors. It is your company’s responsibility to classify your workers correctly and understand the practical and legal differences between employees and independent contractors.
Difference between employee and IC
The biggest difference between an employee and an independent contractor is that an independent contractor has complete control over how and when the work gets done. But the IRS does note that many factors come into play that can blur the line between employee and 1099 contractor. The IRS advises businesses to look at common law rules.
Common Law Rules
Common law rules aid businesses in sorting out the facts as to how much control and independence a worker has, helping to classify them as an independent contractor or not. The facts fall under three categories:
- Behavioral: Does your company control or have the right to control what the worker does and how the worker does his or her job?
- Financial: Are the business aspects of the worker’s job controlled by your company? These include things like how the worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.
- Type of Relationship: Are there written contracts or employee type benefits (i.e. pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of your business?
The IRS states there is no magic number that makes the worker an employee or an independent contractor. Businesses have to weigh all of the factors, as some may indicate the worker is an employee while others point to them being an independent contractor. The IRS stresses the keys are to look at the entire relationship, to consider the degree or extent of control and to document each factor to arrive at a determination. Also note that sometimes state laws override common law. In construction, the designation for specialty contractors is determined by state, and is sometimes counterintuitive.
Misclassification of Employees
There are potential legal troubles for misclassifying an employee as an independent contractor. If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes for that worker. For example, if a worker thinks he or she has been classified incorrectly, Form 8919 can be filed for uncollected Social Security and Medicare taxes. If the social security office agrees with the worker, your company is responsible for covering those back taxes.
Misclassification can also create other tax liabilities, fines and penalties. These include obligations to provide employee benefits, workers’ compensation, unemployment compensation, wage and hour liability, and vicarious liability.
- Employee Benefits: Consider this example: According to SHRM, the court found Microsoft misclassified workers as independent contractors when the company had employed them for years and provided them with tools and equipment. The workers also shared the same supervisors and worked the same hours as full-time employees. The company settled with the employees for $96.89 million with an additional $27.13 in attorney fees and costs.
- Workers’ Compensation: If an employee gets hurt on the job, workers’ compensation protects your company. If that employee is misclassified, the responsibility falls on your company’s shoulders should an injury occur.
- Unemployment Compensation: If your company misclassifies a worker as an independent contractor and they file for unemployment benefits, your company is not only responsible but subject to penalties and interest for unemployment insurance premiums.
- Wage and Hour Liability: Misclassifying workers sets you up for lawsuits. According to SRHM, misclassifying independent contractors invites class- or collective-action lawsuits for unpaid overtime or minimum wage violations under the FLSA.
- Vicarious Liability: Even when a worker has been correctly classified, SHRM states the employer may still be found liable for work that is considered “inherently dangerous activity,” or if the employer exercises control over the work or the activity that caused harm to a third party.
One solution is to file the correct paperwork with the IRS to eliminate confusion and remain compliant with tax laws.
What Forms Do You Need to Hire an Independent Contractor?
There are two forms required by the IRS when you hire an independent contractor and two more that are recommended.
- Form W-9: This form is used to request the correct name and Taxpayer Identification Number (TIN) of the worker. Keep the W-9 in your files for four years in case any questions arise from the worker or the IRS.
- Form 1099-NEC: Beginning with tax year 2020, Form 1099-NEC replaces the previously used Form 1099-MISC for independent contractors. This form is used by companies to report payments made in the course of a trade or business to others for services. It must be filed by any company that pays an independent contractor $600 or more during the year. Your company must send a copy of this form to the independent contractor by January 31 of the following year.
- A Contract: It is a good business practice to create a contract, or written agreement, and have your independent contractor sign it. This agreement should include details about the requirements of the contract, pay rate, non-disclosure and confidentiality. According to The Balance Small Business, if your independent contractor is creating intellectual property, clearly state who owns the property. SHRM offers a free contract template that gives companies a good starting point.
- Invoices: Discuss with your independent contractor how they wish to be paid. Typically the contractor will submit an invoice for work performed either bi-weekly or monthly, depending on your pay schedule. Your company should also state how long accounts receivable requires to remit payment. Many account departments require 30 days to help balance cash flow.
When Should I Hire an Employee Versus an IC?
To summarize, if you’re still unsure whether you should hire an employee or an independent contractor, ask yourself these questions:
- Do you want to control how and when the worker performs the required tasks?
- Do you want to control the hours worked and provide the equipment?
- Will the relationship be long-term?
- Will you offer the worker benefits?
If you’ve answered yes to most of these questions, you are likely looking to hire an employee. If the answers are no, using an independent contractor might be your best bet.
Use Tools to Simplify Payroll
Correctly doling out payments to contractors, non-exempt employees and exempt employees is harder than it sounds, and you don’t want to face the liabilities misclassification can bring. The solution is using a payroll tool, like ExakTime’s Payroll Syncing, that offers an easy bridge between your workforce management system and your payroll package. Correctly classify your workers the first time and their data won’t get lost in the shuffle. Employee data is quickly and easily exported directly into your payroll. Contact us to see how it can simplify your payroll process.