Hiring and Paying an Independent Contractor
Taxes, Contractor Agreements, Backup Withholding
Many small business owners prefer to work with independent contractors rather than hiring employees. Benefits of hiring independent contractors include:
- Flexibility in being able to vary hours worked, or paying by project, and not having to pay when work isn't available.
- Outsourcing non-essential tasks, like IT and maintenance, so you don't have to set up a new department within your company.
- Being able to terminate the relationship easily without the paperwork and potential problems that go with firing an employee.
- Not having to pay FICA taxes (Social Security and Medicare) in terms of taxes, benefits, and agreements. But you must still have a contract (not an employment contract), and there is still paperwork you must complete and taxes that must be allocated.
- Less hiring paperwork, fewer reports, and payments to the IRS.
But, as the hiring employer, there are still some things you must do to hire that independent contractor and start paying that person.
An independent contractor is an individual who does work for another individual or company. The contractor is, by definition, independent, and not an employee of the hiring company.
A perfect example of an independent contractor is a cleaning service. The service comes into your office to do work, but the cleaning service workers are not employees of your company.
Independent contractors are considered to be business owners. They report income on their personal tax returns, and they can deduct business expenses.
For various reasons (mostly to do with payroll taxes), the IRS is concerned that workers are appropriately classified as either independent contractors or employees. FYI: The IRS considers that worker to be an employee unless you can prove otherwise.
The IRS determines the status of workers on a case-by-case basis, and it looks at several factors - including behavioral, financial, and control - to determine status. If you are unclear about the status of people who work for your business, you can request a determination from the IRS.
Mis-classification of a new worker as an independent contractor can create tax liabilities, fines, and penalties for your business, so be sure that the worker you are hiring is an independent contractor, not an employee. This article explains the difference.
The W-9 form serves the same purpose as a W-4 form for newly-hired employees.
If a contract worker doesn't have a tax ID number on file, they may be subject to withholding from their payments (called backup withholding).
- A) Form W-9 (similar to a W-4 form for employees) to provide a taxpayer identification number,
- a copy of the person's resume or professional qualifications, for your own protection and to verify in case of an audit, and
- a copy of the contract. Even the most simple IC relationship should have a contract.
Check Credentials Before Hiring an Independent Contractor
In the same manner, as you check references for an employee, be sure you check the credentials of a contractor before hire. For example, if you are considering hiring a bookkeeper, make sure this person has no felony convictions.
Do a background check on all prospective contractors, in the same way, you check before you hire employees.
If the independent contractor is organized as a business, you should do a check with the Better Business Bureau to make sure no complaints have been filed against this business.
Don't forget the tried-and-true web search, including reviews of the business.
For each independent contractor you paid $600 or more during the year, you must report the total amount paid on Form 1099-MISC and give a copy of this form to the contractor for his/her income taxes.
In most circumstances, you do not need to withhold income taxes from the payments you make to independent contractors. But there are some exceptions:
You as a business owner and payer must withhold taxes on payments to an independent contractor if:
- The taxpayer has not given you a taxpayer identification number (Social Security Number, Employer ID Number, or Individual Taxpayer ID Number)
- The IRS has notified you that the taxpayer ID number is incorrect
- The IRS has notified you that the taxpayer has not reported all interest or dividend income in prior years
In every case, before you hire an independent contractor, create an agreement and get it signed by the contractor. The agreement should include details about the requirements of the contractor, pay rates, and sections about non-disclosure and confidentiality.
If the contractor is creating intellectual property, the ownership of this property should be made clear. Finally, you may want the contractor to sign a non-compete agreement.