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Hiring Your First Independent Contractor: What You Should Know

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As a small business owner, you have a dependable team of employees to handle the bulk of your work, but occasionally you need to reach out to a third party for assistance with special projects or insights. These third parties, known as independent contractors, are fantastic for solving short-term issues or providing a line of work outside the normal scope of what your employees already provide.

Before you hire an independent contractor, you need to be aware of certain restrictions and rules regarding these workers: namely how they are classified, how they are paid, and which tax responsibilities are yours (and theirs). Read on to learn the essentials for hiring an independent contractor.

Know How to Define an Independent Contractor

By its very definition, an independent contractor is independent of your company — and therefore is in business for himself or herself. Three areas the IRS looks at to determine independent contractor status are behavioral, financial, and type of relationship. These refer to whether your company dictates how the worker does their job; who is responsible for their payment and business finances; and what type of contract defines the relationship between your company and the worker.

Some key characteristics of independent contractors include:

  • they typically do not work in your office or facility
  • they are not bound by your employee guidelines nor your employees’ work hours/days
  • they work on projects or short-term campaigns, rather than for indefinite periods of time
  • the terms of their relationship with you are set by explicit contracts

In short: the more control you have over the production of a worker, the more likely he or she is an employee; the less control, the more likely this person is an independent contractor. A full list of determining factors that the IRS uses to declare a worker an independent contractor may be found here.

If you’re still unsure how to classify a specific worker, you may fill out IRS Form SS-8 and have the government determine the status of the worker.

Be Wary of Misclassification

If you misclassify an employee as an independent contractor, you can be liable for severe penalties from the IRS and the California Employment Development Department (EDD) — regardless of whether your error was intentional or unintentional.

You might owe back wages, penalties, and interest for years, and you may be required to pay taxes you otherwise would not be responsible for paying. A list of commonly asked questions regarding the differences between independent contractors and employees in the State of California may be found here.

California employers may be fined up to $25,000 for each violation of misclassification. Further criminal penalties, up to and including a year in prison, may also be imposed.

Understand the Paperwork & Tax Responsibilities

Regardless of the scope and scale of the projects on which your independent contractor will work, you should always have them fill out IRS Form W-9 (the independent contractor equivalent of a W-4 form for employees) to provide a taxpayer ID number. You should also, for good measure, have copies of a resume, professional qualifications and credentials, and a signed contract.

Whether you pay an independent contractor by the project, by the hour, or through some other model, you should know that you are not responsible for withholding any taxes. Unlike with your employees, it becomes the independent contractor’s responsibility to withhold and pay income and payroll taxes, not yours.

Though you are not responsible for any employment taxes, you are required to keep track of your payments. For any independent contractor paid $600 or more over the course of a year, you should fill out an IRS Form 1099-MISC and give a copy to the independent contractor.

Need Help?

If you are unsure of the requisite paperwork for hiring and paying independent contractors, it’s best to reach out to a professional with expertise in the area. If you need help preparing taxes for your workers correctly, an expert can guide you in determining the correct classifications and tax responsibilities. If you’re facing an EDD audit due to suspected worker misclassification, it’s essential to contact a professional tax attorney for assistance, as the audit process can be lengthy and complicated.