Businesses increasingly see the benefits of hiring independent contractors and freelancers, rather than employees. However, there are legal and compliance risks involved. The US Treasury estimated in 2009 that $54 billion of tax revenue was lost through the misclassification of employees as independent contractor. Here we look at how to hire an independent contractor, and how the process differs from the process for hiring employees.
Key Takeaways
1. The first step when deciding whether to hire an independent contractor is. to check whether this makes business sense and complies with employment and tax laws.
2. There are alternatives to directly hiring an independent contractor including contractor management outsourcing and PEO solutions.
3. When you hire an independent contractor, ensure that there is a process in place for the ongoing management of independent contracts.
How Is Independent Contractor Defined?
Before deciding to hire an independent contractor, it is important to understand exactly what an independent contractor is. The best way of doing so is through contrasting the concept with the most common other form of hired professional, an employee.
While there are some differences in how the terms ‘contractor’ and ’employee’ are defined in different countries, generally, we can define the terms in the following way:
An independent contractor is someone who enters into contracts with client businesses to provide specific services to that client for payment. The relationship is primarily contractual, and the contractor usually runs their own business (whether as a sole proprietor, through a limited company, or some other business entity or structure). Obligations of both parties are limited primarily by the explicit terms of the contract.
An employee enters into a contractor with an employer to provide ongoing service to that employer business. A contract exists, but the relationship is heavily regulated by statute and regulations.
You can read more about the differences between contractors and employees at What’s the Difference between Employees and Independent Contractors?
An independent contractor is at arms length from the client and exists in a business-to-business (B2B) relationship with the client.
Sometimes contractors are not independent in this way, and operate as employees of a staffing agency. These individuals are sometimes referred to as agency contractors, and the process known as contract staffing.
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Hire an Independent Contractor Checklist
If you are considering hiring a contractor, we recommend you take the following steps:
- 1. Evaluate the business need for contractors
- The first step is working out whether business needs will be best met by engaging one or more contractors. This includes working out the cost to the business of hiring a contractor rather than an employee.
- This will include working out the approximate cost of that type of contractor in the desired location.
- 2. Evaluate the compliance risk of hiring a contractor
- Once the business has determined that hiring a contractor makes business sense, the business needs to evaluate whether hiring a contractor is compliant.
- Failure to take this step runs the risk of misclassifying an employee as a contractor. This can mean paying back-taxes, interest and penalties.
- Keep mind here as well that the rules for classifying contractors can be different depending on the regulator. For example, tax authority classification can differ from department of labor classification.
- 3. Consider the business model for hiring a contractor
- The business might wish to hire an independent contractor directly. However, this involves setting up invoicing and payment systems, and dealing with potential tax implications (such as value-added tax or goods & services tax in countries where those taxes apply).
- An alternative is to use a contractor management outsourcing provider to take care of your contractors for you.
- Where necessary, it is also possible to convert an independent contractor to an employee at a later point.
- 4. Recruit contractors
- Whether hiring internationally or locally, a third party firm may be able to help with contractor recruitment.
- Where international contractors or freelancers are sought, it may also be worth using third party platforms and market places such as Fiverr, Upwork, Toptal or Guru.
- 5. Onboard contractors
- It is important that a written contract or agreement be in place for the hiring of all independent contractors.
- The agreement set out the specific services to be performed, as well as payment, payment methods and dispute resolution.
- Read more about what should be included in these contracts at What is an Independent Contractor Agreement?
- 6. Manage ongoing relationship with contractor
- As well as managing the contracted deliverables of the contractor, the business needs to ensure that it manages the administration of the contract.
- This means ensuring that contracts are paid on specified terms, as well as ensuring that necessary documents are filed with tax authorities. For example, where a contractor has been paid more than $600 over the year, US companies must file a Form 1099-MISC with the Internal Revenue Service (IRS).
Frequently asked questions
An independent contractor need not be a natural (i.e., living, breathing) person. An independent contractor could be any legal person, including a limited liability company (LLC).
In many cases, it makes sense for businesses to hire independent contractors through a corporate form as matter of due diligence.
A range of personal information, payment, and tax information is usually required to engage an independent contractor. This includes relevant tax numbers, and information for filling necessary tax forms such as form 1099-MISC in the United States.
Self-employment may involved being an independent contractor, but it need not. For example, an individual running their own ecommerce shop, or a food truck, might be self-employed, but not an independent contractor.
No. An independent contractor often has a business classification as a sole proprietor (also called ‘sole trader’) by default. However, the individual contractor can choose to implement operate through another business structure such as a S-Corp, LLC, or a trading trust, if they so choose.
Read more at Independent Contractor versus Sole Proprietor.
The construction industry usually operates via ‘general contractors’, also sometimes called ‘building contractors’ or ‘construction contractors’.
These contractors may be incorporated, or sole proprietorships, and often themselves have multiple employees. It is also common for these contractors to then sub-contract particular tasks (such as plumbing, or roofing) to sub-contractors.
A key difference between an ‘independent contractor’ and a ‘general contractor’, is that an independent contractor usually only contracts out their labor. By contrast a general contractor usually agrees to provide an entire product (such as a house or an apartment building), not just the labor associated with it.
There may be sound business or compliance reasons why a company doesn’t wish to engage an independent contractor, in which case they could consider:
- Hiring employees. Employees can be permanent, part-time, fixed term or ‘zero hours’. Non-permanent options can be useful for businesses that desire flexible human resources
- Engaging a Professional Employer Organization (PEO). A PEO provides an alternative to direct employment or using independent contractors. The PEO employs professionals who then work under the day-to-day management of a client company.
- Contractor management outsourcing (CMO). You still directly engage the independent contractor, but the CMO company takes over all compliance and payment processing tasks for independent contractors.
Conclusion
Many businesses can benefit when they hire an independent contractor. However, before doing so it is important that the business has checked that hiring an independent contractor would make good business sense, and is legally compliant.
Horizons provides independent contractor recruitment and management services, as well as global employment solutions for businesses that seek to employ.
Don’t hesitate to contact us to discuss the best option for your business.
