Independent Contractors

As a businessperson, you may hire independent contractors—or you may be one. In fact, there is no reason why an independent contractor cannot hire a colleague who is also an independent contractor. This may seem confusing on the surface, but the rules for defining an independent contractor apply whether you are the one who is doing the hiring or the person who will actually perform the work.

Who is an independent contractor?

In the loosest terms, people who work on their own, often for multiple customers or clients, without a traditional paycheck (and all the deductions that go with it) or employee benefits, such as health care coverage, are independent contractors. These people are in business for themselves. You can find them in a huge range of occupations from the professions (a lawyer, for instance), to the trades (such as a plumber or carpenter), to service occupations, (for example, a massage therapist or independent public relations person).

There are, however, tighter definitions of independent contractor, and they are important for legal and tax purposes. Even so, you will not find a single-purpose definition of the term. Agencies ranging from the IRS to state tax departments have come up with their own characteristics.

For the IRS, the primary consideration in differentiating between an employee and a contractor is the amount of control that the business exercises over the worker. “A general rule is that … the payer [has] the right to control or direct only the result of the work done by an independent contractor, and not the means and methods of accomplishing the result,” according to the IRS.

The amount of control and independence can be considered in light of the following three categories:

  • Facts governing behavior control would demonstrate whether the business can direct and control work through instructions or training or similar actions.
  • Financial control would relate to the extent to which a worker can realize a profit or incur a loss, the amount and kind of unreimbursed business expenses and how the business pays the worker.
  • Examples demonstrating the type of relationship would be indicated by written contracts describing the relationship, the extent to which the worker could do similar work for other businesses and aspects of the permanency of the relationship.

What are the benefits of being an independent contractor?

Many workers would never consider giving up their lives as independent contractors. They love being their own boss and feel they have more control over their destiny (and the amount of money they earn).

Independent contractors may pay lower taxes. Business-related expenses can be deducted, and there are several tax advantaged retirement plan options that allow saving for the future.

So what is the downside of being an independent contractor?

For one thing, there is no steady paycheck. The life of an independent contractor can be feast or famine—being buried in work one month and worrying about the mortgage payment the next. And there are no employer-paid benefits; contractors have to cover their own payroll taxes, health insurance and give up income if they take a vacation. They also are not eligible for unemployment benefits.

Contractors are liable for any business debts they incur, and there is always the risk that a client or customer will not pay their bills.

What are the benefits of hiring an independent contractor versus an employee, especially if I ca not exert as much control over a contractor?

A company does not have to pay payroll taxes and benefits for an independent contractor, although an hourly rate for a contractor might be higher than what an employee would receive. Also, a company can maintain flexibility with its workforce, not just in the number of workers, but also the skills that the business might need at a given time.

One of the most important benefits of hiring independent contractors is that the hirer does not assume tort (personal injury) liability for an independent contractor.

Do I need a contract to hire an independent contractor?

A written contract benefits both the contractor and the business because it defines the work relationship as well as the obligations of each party. It shows government agencies that the intent is to create a relationship that meets the requirements for independent contractor status.

In the contract, address these topics: the amount, timing and conditions of payment; the actual work to be performed; who pays expenses and how reimbursable expenses will be handled; the length of the contract and how it can be terminated, as well as how disputes will be resolved. There should also be a section that addresses the independent contractor’s status, such as licenses held and equipment he or she will provide.

Will I own the copyright to work I create as an independent contractor?

Maybe. If a business hires an independent contractor to create a work that could be subject to copyright law, the business does not own the copyright to the work. To own the copyright, there must be an assignment of ownership in writing, which should be part of the hiring agreement.

In some cases of creative works, the concept of “work for hire” applies. That means, under the work for hire law, the hiring entity is legally considered to be the work’s author and has copyright rights. Again, there must be a written agreement stating this.

The nine specific work for hire categories include translation, a test and its answers, contribution to a collective work (e.g., a magazine), an atlas, a compilation, an instructional text, a test, answer material for a test or a supplementary work (e.g., a foreword, chart, illustration, editorial note, bibliography, appendix, index).

What happens if I hire someone as an independent contractor, and later the IRS says I must classify that person as an employee?

The penalty for this mistake is pretty stiff. Not only does the employer have to pay back taxes (and interest), there is a penalty of up to 35 percent of the tax owed.

It is also possible to get in trouble with your state, especially if a former contractor applies for unemployment compensation.

What are some tips on making sure independent contractor status is retained?

One tip is that a business should check on how the independent contractor has been functioning in the recent past. That is, what recent work has he or she performed that could be deemed comparable? The contractor can be asked to fill out a questionnaire that will give the appropriate information.

Is freelance the same as independent contractor?

A freelance worker is one who works for himself or herself, for different employers and without a long-term contract. Typically a writer or artist, a freelancer could also be an independent contractor.

Is a consultant the same as an independent contractor?

A consultant is defined as someone who gives expert or professional advice, and many consultants function as independent contractors. However, there are many consultants who work for companies or partnerships, so in that case they would not be independent contractors.