Independent Contractor Hiring Checklist: Tax Forms & Paperwork
A company may enjoy many benefits of hiring self-employed individuals.
The company's business expenses are lower since it doesn’t have to invest as much in independent contractors as they would in their employees as contractors typically don't need any training and use their own tools. In addition to the resources saved in these aspects, the company wouldn’t have to pay payroll taxes (Medicare taxes or workers’ compensation insurance, for example).
This being said, independent contractors’ compensation could be higher than a regular employee’s for the same job. However, since most of them are small business owners, they’ll take care of their self-employment taxes and contributions, thus, at the bottom line, they’re still cheaper than having regular employees.
However, regardless of the type of the working relationship between employers and workers, taxes have to be paid. Here's what you need to know about taxes when hiring workers with an independent contractor status.
Documents and tax forms to collect when hiring independent contractors
1. Form W-9 (for US-based contractors)
The basic form needed to hire an independent contractor is the IRS form W-9, Request for Taxpayer Identification Number (TIN), and Certification. The Form W-9 helps the client collect information about the contractor for tax purposes. A company should send a blank Form W-9 to the contractor, and they will put in their information and return it.
The W-9 form should contain the following things:
- Name - and a business name, if the contractor is “doing business as”
- Address
- Taxpayer Identification Number (TIN) - if the contractor is an individual, they can use their Social Security Number, if they’re not, they will need to use their Employer Identification Number (EIN)
Keep in mind that the Form W-9 should be submitted only once and before the contractor starts working for the company. If the independent contractor’s information changes, they will need to submit the updated Form W-9 again.
It is essential that the information in the form is valid since it will be used for submitting various other forms, such as form 1099-NEC.
Learn more about Form W-9.
2. Form 1099-NEC
Once the client has the Form W-9, they can use the information in it to submit the Form 1099-NEC, Nonemployee Compensation. Even though it is not needed to hire an independent contractor, it is still a necessary part of the paperwork a company needs when working with a contractor. This form used to be a part of Form 1099-MISC box 7. However, as of 2020, 1099-NEC is a separate document.
The Form 1099-NEC is used by the IRS to determine taxable income acquired by contractors and freelancers.
It is used to report payments a company made to an independent contractor within a tax year. A company will need to submit this form as long as it has paid an independent contractor more than $600 in a tax/calendar year. So, even if the two haven’t worked together for a year, the company will still need to report the remuneration provided to a freelancer or contractor, as long as it exceeded $600.
Apart from the information found in the W-9, Form 1099-NEC should contain:
- The amount the payer (company) transferred to the payee (independent contractor), that is susceptible to income taxes
- Any tax withholding that was done and for what purposes
The due date for submitting 1099-NEC is January 31st of the following year, for the previous tax year.
Payments made to independent contractors via credit card, debit card, or third-party systems (such as PayPal) are not calculated on the 1099-NEC or 1099-MISC.
Learn more about Form 1099-NEC.
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Learn more3. Form W-8BEN (for foreign contractors)
IRS form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting, is used for hiring independent contractors from overseas.
By filling out the W-8BEN form, the client provides proof that the person hired is not a US citizen and conducts work from outside of the US.
This form is issued by the IRS, but should not be submitted back to it. Instead, the foreign contractor submits W-8BEN to the payer of their contract, to serve as proof that the foreign contractor is exempt from taxes or pays a lower tax rate.
If the foreign party isn’t an individual, but a business entity, they will need to fill out IRS form W-8BEN-E and submit it to the payer.
Learn more about Form W-8BEN.
4. Form SS-8
The IRS form SS-8 is used for “Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding”. Basically, this is the form that the company can fill out to determine the classification of the person they hired: either an independent contractor or an employee. However, this form is not mandatory but can help to avoid misclassifying workers.
The forms and paperwork needed to hire an independent contractor are not the same as those you’d use for a regular employee. The distinction between a nonemployee and an employee is crucial. Certain factors, such as a high degree of control, define an employee status and require employee benefits. The misclassification of full-time employees as independent contractors can lead to severe penalties from the IRS.
Learn more about the difference between independent contractors and employees.
5. References and Resume
Before a client decides to hire any freelancer or contractor, the latter will need to provide some form of resume about their previous experience and skill set.
Even though these aren’t exactly tax forms and will not participate in determining either the client’s or the contractor’s tax returns, they still fall under the category of documentation needed to hire independent contractors and they are crucial to the hiring process.
6. Contract Agreement
Before a company hires anyone, it should construct a written contract for each open position. When hiring freelancers or small business entities, the company should make an independent contractor agreement, and bear in mind that, even if you're hiring a contractor for a short-term project, an employment contract is always necessary in order to protect both sides.
The contract with an independent contractor should have:
- The scope of work - what will the contractor be doing for the company, what will it entail
- Ownership of said work - who will the intellectual property belong to once the work is finished
- Compensation - remuneration the company will provide to the independent contractor
In addition to this, a contract may contain specific information depending on the local state laws and the policies of the Department of Labor.
Read more about how to draft a well-written contract.
Additional agreements with independent contractors
In addition to the mandatory documentation required to hire an independent contractor, the client might ask for a few other legal agreements to be signed.
Confidentiality agreements
The most common of restrictive covenants signed between employer and employee is the non-disclosure agreement (NDA). This document prevents an independent contractor or employee to discuss what they’ve been working on while employed in the company.
NDAs can cover specific projects or anything that happened during the time a contractor has been working for the company.
Non-compete agreements
If the client who is hiring an independent contractor deals in a competitive market, they may ask the contractor to sign a non-compete agreement. This agreement states that the contractor won’t compete with the client (or former client) in the same field for a certain period of time. Non-compete agreements usually last for a year or two.
Non-solicitation agreement
This document is similar to the non-compete agreement, but it covers a different aspect of doing business. While the non-compete agreement forbids the employee from working in a certain field, the non-solicitation agreement prevents a former employee from stealing any of the company’s clients.
Even though most of these come into play only after the client and the contractor have already parted ways, it’s a good idea to present them to any independent contractor before they’re officially hired. This will let everyone know what they’re getting into and might even present deal-breakers for some contractors (especially small business owners).
7. Invoices
Whether they have their own business or they’re freelancers, all independent contractors should provide invoices to their clients. An invoice should contain:
- Invoice number
- Client’s information - name, address, VAT ID number
- Contractor’s information - name, address (VAT ID number, TIN in case the contractor is a business entity)
- Services provided to the client
- Amount of compensation for those services
- Additional information that may affect the total amount (bonuses, deductions, etc.)
Invoicing clients can be tough, especially if there are a lot of clients to be invoiced. Writing a proper invoice can also differ depending on who is being invoiced and where. Learn how to create an invoice.
How to keep your paperwork in order
With so many documents and tax forms required to hire an independent contractor, it is a real wonder how anyone does it. Most people are troubled by the sheer amount of paperwork.
Luckily, there are many bookkeeping tools, that provide templates, and will allow anyone to stay organized and keep track of their business, whether big or small.
Unfortunately, not everyone has the time to learn how to master these tools and most businesses hire an accountant to keep track of who they hire, what taxes they should withhold, and which forms to submit.
Finally, it's worth considering outsourcing the hiring and payroll process for independent contractors. It will be a good investment that will keep your focus on the core of your business and give you peace of mind when it comes to handling paperwork.
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