A client of mine – who has started a cool mobile app company – recently wanted to hire an independent contractor for helping on the development of the product. He asked for some advice and here’s some of the key issues I noted:
Legal Stuff: A company does not have to withhold taxes or pay benefits for an independent contractor. Yet the IRS understands the potential for abuse. As a result, whenever there are independent contractors, there is a higher likelihood of an audit. And if the employer loses the fight, it could mean heavy penalties, back taxes and interest.
The problem is that there are really few clear-cut guidelines (except for narrow categories like direct sellers and real estate agents). For the most part, the key is that an independent contractor must have control over the activities.
In other words, if the business owner has stringent rules for the person to follow – such as a set schedule to work at the office — or training, then he or she will probably be considered an employee. The same would be the case if the business owner provides all the tools for the work
On the other hand, a person is likely an independent contractor if he or she:
- Works on a project basis
- Has multiple clients
- Advertises for his or her services
- Pays the expenses
- Provides specialized skills
Taxes: For payments to contractors, you will get to take a deduction. But you also must abide by some regulations, such as issuing 1099-MISC forms (for those who have annual payments of at least $600). Copies must be sent to the contractor as well as the IRS.
Contract: Make sure you have an independent contractor agreement – and call it an “Independent Contractor Agreement” (at the top of the document!) In fact, this is important evidence if there is an IRS audit.
Part of the language should clearly note that:
- There will be no federal withholding or benefits
- The terms and information shared are confidential
- There should be no solicitation of clients or employees (known as a “Nonsoliciation clause”)
- There should be a right to terminate the contract if the work is substandard, violates terms of the agreement or there are missed deadlines.
In the contract, you should also have a clause that grants all ownership of the independent contractor’s efforts. This is especially important in the tech space.
It is also critical to be detailed about the requirements. Often disputes arise over the mismatch of expectations of the parties. So in the contract, more detail is probably better — and also have specific dates for deliverables.
As for the payment, it is advisable that it be on some type of fixed basis. If not, the IRS may think there is really an employee relationship involved.