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Engaging independent contractors (ICs) in the U.S. is a great way to have top talent working on your projects. These freelance professionals offer their clients many benefits, but remember that freelancers are business owners. You must treat them as such. Failing to do so may lead to costly legal troubles.

To help you avoid potential trouble, keep these few basic concepts and best practices in mind.

What’s an independent contractor?

Let’s start by making sure we’re talking about the same type of workers. Freelancers, consultants, agencies…these are all types of independent contractors (ICs). Unlike temporary employees (temps), ICs are self-employed instead of being employed by another company or staffing firm.

Freelancers are skilled independent professionals, who run their own business. They’re often a sole proprietor under a separate legal entity, like a limited liability company or a corporation. They often specialize in areas including IT, engineering, creative, and legal. And they typically work on a project basis.

How do you work with an independent contractor?

When working with freelancers and other ICs, it’s important to treat them like the independent experts they are. An easy way to think about it is, if you hire an accounting firm to prepare your taxes, you expect your taxes to be done on time. But you don’t teach them how to do taxes or tell them how to prepare your returns, do you?

Expectations

Freelancers/ICs work on a project-by-project basis. These independent professionals maintain total freedom over how they get the work done. Here are some best practices to keep in mind:

  • Freelancers are already experts in their fields. You should not tell them how to do the work.
  • Focus on results. Describe what you need done and the expected results (e.g., build a new company website with x, y and z features).
  • Freelancers have expertise and the tools to perform their services. This is part of the investment in their business. You should not provide tools, training, or equipment to do the work.
  • The IC organizes their business as they see fit, which includes contracting parts of the project out to others. But the IC remains responsible for the final work.
  • ICs are juggling your needs with the needs of their other clients. ICs can work any time, any hours, from anywhere.
  • The IC is responsible for meeting the agreed to deliverables and deadlines.

Contracts

Before starting a project, you should have a contract in place per IC and per project. In certain states, like New York, IC contracts are a requirement. However, even for states where a contract isn’t required, create one still. Because this clarifies expectations for a smoother engagement.

What’s more, not having an agreement per project and per IC is one of the three red flags that can open you to misclassification risk. The Department of Labor (DOL) or Internal Revenue Service (IRS) might assume the individual is an employee, which can result in huge tax penalties and damages.

The IC contract doesn’t have to be complicated. It just needs to lay out the work to be done, deliverables, deadlines, and payment terms. Most of the details can be copied from your job post—subject, of course, to any subsequent negotiations.

How are independent contractors paid?

Remember, an independent contractor is running a business. Unlike employees, you are not responsible for benefits and taxes such as Social Security, Medicare tax, unemployment tax, or sick leave.

Deciding on hourly vs. a fixed rate

You and the freelancer can decide whether the work should be paid on an hourly or per project basis. Some freelancers prefer fixed price, some, like lawyers and accountants, traditionally get paid by the hour.

Paying hourly may be a good option if the project’s small. Paying a flat (fixed) rate for the project may be ideal if your project is clearly scoped with finite deliverables. In this option, payments are usually made at predetermined project milestones.

Paying minimum wage and overtime

Under the Fair Labor Standards Act (FLSA), true independent contractors are not employees. Therefore, they are not covered by overtime laws. And the minimum wage payment requirement does not apply either. Like any business, it’s up to the freelancer to decide how much their time is worth, how much time it’ll take to get the project done, and how much it will cost to complete the project.

Tax responsibilities

For every freelancer you pay $600 or more during a year, you are required to send the individual a 1099-MISC form. The form shows the IRS the freelancer’s total earnings for the year and must be received by the end of January, for the preceding year. You are not responsible for paying any taxes.

When to consider payroll services

If you think the worker might really be an employee, or you want more control over how the independent contractor will work, consider using outside employment provider services to handle payroll and benefits administration. Outside services not only protect you from misclassification risk, they can also save you on costs and administration time.

Determining worker classification

One of a company’s biggest responsibilities is accurately classifying each worker, per project. And you want to get it right, because a mistake can lead to fines and penalties. Unfortunately, classification can be a tricky, because U.S. worker classification laws aren’t black and white. Instead, they’re more of a balancing act.

Balancing multiple tests

To start, you can classify the individual according to federal tests. The most commonly used U.S. classification tests are the IRS 20-Factor Test and the Economic Realities Test.

Then check yourself against the state tests—each state has its own. After that, consider other circumstances, such as if you work in one state, and the freelancer works in another. Then check the laws again to see if you need to treat the worker differently.

If you hire freelancers outside the U.S., you must add on another layer of tax and labor laws for each country you work in.

Check your assumptions

When classifying U.S. workers, keep these key points in mind:

  • Being an IC for one law does not necessarily make them an IC for other purposes (e.g., unemployment or workers’ comp).
  • Receiving a 1099 or signing an IC agreement does not necessarily make them an IC.
  • Having an EIN and an LLC or other business entity does not necessarily make them an IC.
  • Working from home or from another location away from the client’s worksite does not necessarily make them an IC.
  • Being a bona fide IC in the past does not necessarily make them an IC now. It’s a best practice to classify a worker at the start of each project.

As you can imagine, classifying ICs requires significant internal resources. And hiring outside legal counsel to classify each person per project can be cost-prohibitive. To avoid risk and stretch resources, larger companies use compliance services.

If you need ICs for multiple projects, you may want to streamline everything from sourcing to compliance to payment through Contingent Management Solutions. These systems enable enterprises to secure top talent faster. And they ensure enterprises follow all related tax and legal considerations—no matter where the IC is located.

This article does not address all tax or legal issues relating to worker classification and should not be taken or relied on as tax or legal advice. Please reach out to your own tax or legal advisors for advice on your particular situation.

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