The ways in which people work, live and spend their money have changed dramatically in the last decade. Smartphone technology and hyper-connectivity are key factors to the revolution. Apps such as Uber, Lyft, Takl and Fiverr provide opportunities to hire freelancers for short term projects. As a result, many experts label our current economy as a “gig” economy. Through temporary work assignments (gigs), the so-called “gig economy” is altering the way people perform and view work.
The gig economy is comprised of three main components: 1) independent workers paid by the task or project as opposed to workers who receive a salary or hourly wage, 2) consumers who need a specific service (i.e. a ride to a destination), and 3) companies that directly connect workers and consumers (e.g. Uber, Etsy, etc.).
While performing short term projects for work is not a new concept, the number of people participating in the system has grown extensively. In fact, researchers Lawrence Katz and Alan Krueger determined that the share of the U.S. workforce participating in the gig economy rose from 10.1% in 2005 to 15.8% in 2015.
Independent contractors make up one sector of this ever-expanding gig economy. The most recent Department of Labor statistics identified over 10.6 million independent contractors in May 2017.
So what is an independent contractor? Are they a beneficial hire for your business?
What exactly is an independent contractor?
An independent contractor is an individual who performs work for another individual or company. By definition, they are independent and not an employee. The independent contractor is self-employed and provides a service to another business.
For example, a graphic designer working for another company on a per-project basis is considered an independent contractor.
What is the difference between an independent contractor and an employee?
For tax purposes, it is important to know who does and does not qualify as an employee. The IRS recognizes a range of non-employees, including independent contractors. It is extremely critical to correctly classify individuals performing work for you. Misclassifications can result in potentially expensive situations involving back taxes, penalties, and fines.
Note that the IRS presumes a worker is an employee unless proven otherwise.
Generally, the degree of control you wield over a worker determines their status as an independent contractor or employee. The IRS considers three key criteria to determine a worker’s status:
- Behavioral – Does the company control what the worker does and how they complete their job?
- Financial – Are the business aspects of the worker’s job (e.g. method of payment, expense reimbursement or provider of tools/supplies, etc.) controlled by the payer?
- Type of Relationship – Are there employee type benefits? Will the relationship continue? Is the work performed a central aspect of the business?
No single factor determines a worker’s status. Further complications arise when realizing that the IRS, Department of Labor and other agencies have different definitions of an employee.
If it is still unclear whether an individual classifies as an employee or independent contractor, you can file Form SS-8, “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Taxes Withholding” with the IRS. Either the business or worker can file the form. The IRS will then review the facts and circumstances.
How can hiring independent contractors benefit my business?
There are many advantages for companies, especially small businesses, to hire independent contractors. The benefits of hiring independent contractors include:
- Hiring workers on a per-project basis and letting them go upon completion
- Flexibility in being able to vary hours worked, paying by project and not having to pay when work is not available
- Out-sourcing not essential tasks like IT and maintenance
- Ability to terminate a relationship without paperwork and avoid potential problems that arise when firing an employee
- Not having to pay FICA taxes (Social Security and Medicare) in terms of taxes, benefits, and agreements
- Not having to provide workers compensation
- Less hiring paperwork, fewer reports and payments to the IRS
What steps do I need to take when hiring independent contractors?
If you determine that hiring an independent contractor is advantageous for your business, there are some aspects to keep in mind.
Hiring an independent contractor is different than hiring a traditional employee. For instance, there is far less paperwork involved because you do not have to set up payroll taxes (income taxes and FICA taxes). However, there are three key documents you will want to secure. These are vital in case of an audit.
1. W-9 Form
You must document your payments to outside workers. If you pay anyone, with a few exceptions, $600 or more in a single year, you are required to provide this person or company with a Form W-9. This form includes the contractor’s taxpayer identification number, name and address.
You must have a W-9 on file for each independent contractor in order to avoid withholding income taxes from that individual. With a W-9, you also have the information to create a Form 1099-MISC for that person for the tax year. This is similar to a W-2 form for an employee.
It is imperative to provide the 1099-MISC to the contractor no later than the last day of January the following year. They require this form to pay their income taxes for the year. Additionally, you must send a Form 1096 to the Social Security Administration by the end of February, along with copies of the 1099 forms.
Please keep in mind that your specific state may have additional forms related to income tax withholding. For example, California has a “California Independent Contractor Agreement” designed specifically for contractors in the state. Click here for an example of said agreement.
2. Application, Resume or Documentation of Qualifications
Prior to hiring anyone, we recommend that you obtain a copy of any documents demonstrating the qualifications of the person. It is beneficial to attain detailed information related to education and prior work history in order to both protect yourself and to verify in case of an audit.
If the worker is performing confidential, financial or other critical work, you should complete a background check and follow up with references.
3. Written Contract
You should have a copy of a contract on file, signed by both parties, for each independent contractor. This acts as a method of protection in the event of a dispute.
Issues to address in the contract include:
- Explicit designation as independent contractor
- Scope of the work
- Amounts and timing of payments, when payments are due, and consequential action for missed payments
- Assignment of the ownership of the work
Depending on the type of work performed and the nature of your business, there are other agreements you may want to introduce to an independent contractor relationship.
A confidentiality agreement (or non-disclosure agreement) requires the worker to keep potentially harmful information about your company confidential.
A non-compete agreement outlines the restrictions on the worker upon leaving your company. Notably, the agreement restricts the former contractor from owning a competing business within a certain area and time after leaving the employer. This prevents them from doing work that directly competes with the former business owner.
Once you’ve hired an independent contractor, how do you get the most out of them?
As Zoe Harte, Senior Vice President of HR and talent innovation at Upwork, says, “As the use of independent workers continues to increase, it’s imperative that companies develop consistent processes for how they inform and communicate with the team, including how they welcome freelancers, set expectations and measure outcomes.”
Harte, in collaboration with Society of Human Resource Management (SHRM), recommends the following to help your business understand and better utilize independent workers:
- Allow for growth and development opportunities as a means of establishing strong relationships.
- Shift management of the independent workers from transactional to strategic and collaborative.
- Update HR policies, processes and philosophies to provide independent workers with a more positive experience.
- Use technology to facilitate more effective and efficient onboarding, project workflow and information-sharing tools.
- Welcome ideas from independent workers while encouraging permanent employees to collaborate and build relationships with them.
- Give recognition to independent workers who demonstrate a clear and positive value to your business.
If you would like more information on how hiring an independent contractor could benefit your company, please contact us today.
Disclaimer: This material has been prepared for informational purposes only, and is not intended to substitute for obtaining accounting, tax, or financial advice from a professional tax planner or financial planner. All information is provided “as is,” with no guarantee of completeness, accuracy, timeliness or of the results obtained from the use of this information.