Have you ever considered hiring independent contractors for your business? If you aren't doing it already, you are missing a great opportunity. Many business owners leverage the gig economy to improve their business by hiring independent contractors. However, there are a few challenges that arise; Apart from hiring independent contractors compliantly, you need to consider the best way of paying them. We have tackled the most important challenges that you can face, the paperwork needed to compliantly hire contractors, as well as a detailed list of all payment systems.
What is an independent contractor?
An independent contractor is a self-employed individual or entity hired to perform a service to a company. Contractors are performing services to the general public. According to the IRS, the independent contractors have the independence of the way the work is being done, allowing the company that hired them the right to control only the result of the work.
Read more about what is an independent contractor.
What are the benefits of hiring independent contractors?
There are many benefits of hiring independent contractors. If you are a small business owner, an independent contractor can help with some of the short-term workloads, allowing you to focus on the core of your business.
The main benefits of hiring an independent contractor are:
- Minimal training required - Independent contractors are usually very skilled workers, who are hired based on their specific knowledge and don't require any training.
- Cost-efficiency - Even though sometimes, at first, independent contractor fees are higher than full-time employees' hourly rates, the total business expenses of one employee is much higher, given that the businesses who work with contractors do not cover traditional employee benefits, and there is no backup withholding, which makes hiring them very cost-effective.
- Staffing flexibility - Since independent contractors are usually hired short-term or on a need-basis, you will have better management of the business expenses. The flexibility enables you to hire the contractors when and for as long you need them.
Read more about the benefits of hiring independent contractors.
Make sure you're not at risk of the employee misclassification
Misclassification is one of the most common issues when hiring independent contractors. There is certain criteria that needs to be met in order for someone to be a contractor. Independent contractors usually perform the work on their own terms, allowing the employer to control only the result of the work.
This is because tax implications are different for employees and contractors. Employers are required to do backup withholding from their employees' salaries, causing them to spend a significantly higher amount of money on them. If the IRS decides that your independent contractor should in fact be your employee, you will be required to pay all of the Social Security and Medicare taxes (FICA taxes), along with unemployment taxes.
Make sure that you have aligned any written contract and your business relationship accordingly. For a more detailed overlook, check our employee misclassification guide.
Before hiring and paying independent contractors: Collect the necessary paperwork
Let's tackle the legalities. Before you start working with an independent contractor, there are a couple of things that you need to do.
- Collect Form W-9: This form contains the name, address, and Social Security Number or Taxpayer Identification Number (TIN) of an independent contractor. This form is not filed to the IRS but is necessary to be kept on record before the first payment is made.
Read more about Form W-9
- Sign a written contract: Sign a contract with your independent contractor regardless of the size or length of the engagement. In the written contract, outline the scope of work and the payment terms, as well as any other clauses that can protect you or the contractor.
Read more about how to draft an independent contractor agreement.
How are independent contractors paid?
Since independent contractors are considered to be non-employees, they receive compensation based on the work that they perform. They can be paid in two ways:
- By the hour: If the independent contractor is a freelancer or a consultant, they will most likely have an hourly rate for their services.
- By the job: If the independent contractor is hired for a specific project, they will most likely have a defined compensation based on the work they perform.
Withholding and deductions for independent contractors
In general, you don't need to withhold any taxes when you make a contractor payment, as long as you have Form W-9. However, in case you are missing the W-9 or any of the information such as the contractor's TIN is incorrect or missing, you are obligated to withhold federal income tax (called backup withholding). The IRS will instruct you to perform the backup withholding in a notice.
How do independent contractors pay taxes?
Independent contractors are usually sole proprietors or business owners themselves, which means that they are responsible to pay their own tax payments and other benefits such as health insurance, pension plan, etc.
If they operate under a sole proprietorship, they are paying their own taxes such as self-employment tax and federal income tax.
Read more about independent contractor taxes.