Most businesses are looking to hire independent contractors over employees thinking they cost less than employees, allow the business to have more flexibility in how they are used and present less risk. While some of that may be true depending on the situation, there are compliance issues to be aware of when using contractors over employees. Compliance is often seen as a costly necessary evil, but strong compliance is critical in the success of your business.
More than ever people are working from home, looking for flexibility and control over their work life and exploring the gig economy. These considerations lead a lot of people to explore the route of providing services to companies as 1099 independent contractors, in particular to a small businesses who are looking for help but for a variety of reasons don't want to commit to an employee.
Gig workers will likely continue to be prominent and a viable option for business owners to get some much needed assistance without bringing on an employee and jumping through the hoops that involves. That doesn't mean there aren’t potential issues with independent contractors, and that a company shouldn’t have an independent contractor policy for dealing with those workers. Going into it blindly can open up a host of issues that could lead to fines, penalties, back payments, and multiple lawsuits.
Business owners should put some serious thought into their options when it comes to bringing on workers, just because an independent contractor appears to be the easier and simpler option doesn't mean it fits the need. Improperly using an independent contractor could end up costing much more in time and money than bringing on an employee.
Here are some steps you’ll want to consider before bringing an independent contractor on board.
- If you haven’t already done so, you’ll want to register as an official business entity with the applicable state office. It may be that you’ve been operating as a sole proprietor or a partnership up until now. If that’s the case, it’s time to become an LLC or a corporation, for a variety of reasons, being a sole proprietor or a partnership usually isn’t the ideal situation for any business owner to find themselves in. So, if you’re bringing on a contractor, make sure you have your business entity set up, your EIN, and any other corporate formalities you might need to address (bank account, business license, DBA, etc.) are taken care of. This is an important step in limiting personal liability, and if workers are coming on, limiting personal liability should be a priority.
- Make sure you understand the difference between an independent contractor and an employee. The Department of Labor, the IRS and states may all be using different “tests” to determine whether a worker is an independent contractor or an employee. The general rule is you aren’t going to misclassify a worker by making them an employee, and that would prevent any potential classification issues. That said, plenty of businesses use independent contractors without classification issues from the federal or state government; the key is making sure that you understand how to properly classify your workers and do so appropriately. Be aware that it’s not uncommon for “gig workers” to want to be classified as independent contractors, but just because a company and a business agree that they want to classify the relationship as an independent contractor doesn't’ mean that it is under the various tests in use. Furthermore, and agreement between the company and the worker on classification won’t prevent penalties, fines and other punishments being levied on the business for misclassification.
- Carefully define what type of support or work it is you need to be done. Writing out a job description and defining what you want the relationship with the worker to look like is helpful here. Many of these considerations have implications for how you will need to classify the worker, so the more you can map out the relationship, the work and your expectations, the better. Some things to consider when you’re doing this:
- Is this a one time project that isn’t directly related to the core service you provide or product you sell?
- How are you going to pay; how much are you going to pay them?
- Are you going to be providing them with all the tools and equipment they need in order to perform the work?
- Will you need to manage how the work is done?
- Will you need to manage when the work is done?
- Can the work be done remotely?
- Make sure to create an independent contractor agreement. Like any relationship you have in your business, internal and external, you’ll need a contract that lays out the obligations, responsibilities and other criteria important to the agreement. It gets everyone on the same page at the beginning, helps prevent disputes down the road and can set up some dispute resolution mechanisms should one arise. It will, or should, also lay out your options for getting out of the contract if things aren’t working out like you envisioned.
- Address ownership of the services, deliverable or work product that the contractor will be providing. Think about what the independent contractor is doing for you; is it creating an asset that could be valuable to your company now and in the future? If it is, you’ll want to make sure that you specifically address ownership rights and intellectual property rights. You’ll want to make sure that it is spelled out in writing, it can be in the independent contractor agreement, so there’s no confusion and that everyone understands you’ll own the rights when the work is done. Don’t overlook this and end up in a situation where you don’t own a valuable asset you paid to have created.
- Be careful not to treat an independent contractor like an employee. Treating independent contractors like employees is an easy way to end up with a misclassification situation. Contractors aren’t entitled to any of the typical employee benefits - vacation and sick days, health benefits, financial plans like a 401k, other perks or incentives that are for employees. Another situation to avoid is giving contractors policies and handbooks that are made for employees. By the nature of the relationship, independent contractors are allowed a measure of freedom not typically afforded to employees, making them sign policies, procedures, handbooks and other documents similar to what employees get is going to work against classifying them as a contractor.
- Remember that employee tax law doesn’t apply when it comes to independent contractors. Contractors should cover their own taxes, expenses and costs. The business owner should only cover the payment or compensation outlined in the agreement.
Properly classifying a worker isn’t as straightforward as many business owners think. The classification is up to the company not the worker, just because someone wants to be classified as an independent contractor doesn’t mean they should be. If you’re caught up in a misclassification issue on the state or federal level, it’s the business that’s going to be in trouble, potentially big trouble, not the contractor.
Have questions about independent contractors, bringing them on and properly classifying them? Contact us for a free consultation.