5 Tax Experts Weigh in On Hiring Contractors

With the rise of the gig economy and freelance workers, more and more small businesses turn to contract workers, as opposed to full- or part-time employees. A recent NPR and Marist poll estimated that 20 percent of American workers are contract workers. A figure which is expected to rise in the coming years.

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As our workforce faces this evolution, small business owners and managers look to hiring alternative professionals, instead of traditional employees. However, independent contractors can present unique challenges in terms of proper tax classification, payments, documentation, and even behavior.

If you’re a small business owner considering hiring an independent contractor, consider this advice from five tax experts.

1. Understand the Nuances of Independent Contractor Classification

Business owners and managers might hire and classify an individual as an independent contractor for several reasons. For example, you could need short-term or specialized work, or you can’t afford a full-time employee (payroll taxes, worker’s compensation, benefits, over-time, etc.). However, just because you classify someone as an independent contractor doesn’t mean state agencies will see it the same way.

Robert T. Leonard, a tax attorney and CPA, explains that several organizations, like the Employment Development Department, and Franchise Tax Board (to name a few), have different guidelines for the independent contractor classification. What’s more, they all have separate and distinct stipulations.

He explains that as such, the same individual may be considered an employee in the eyes of one law while a contractor under the regulations of another. What’s more, the independent contractor status also varies depending on the industry, job requirements, and several other factors.

Bottom line: “There is no set definition of the term ‘independent contractor,” says Leonard. To avoid significant penalties or potential liabilities, speak to a tax lawyer or experienced HR professional to advise you on properly classifying independent contracting roles within your business and avoid potential tax penalties.

2. Complete the Correct Paperwork

Logan Allec, a CPA, personal finance expert, and owner of personal finance blog Money Done Right, gives a run-down of all the paperwork a small business owner should have on hand when working with independent contractors.

  • Form W-9: A contractor should fill out a Form W-9 before they begin work. Get this immediately, so you have all the correct information should you need to issue a Form 1099. Always acquire the proper documentation prior to starting a new project or work.
  • Form 1099-MISC: Many small business owners think that they need to issue all of their independent contractors a Form 1099-MISC. This may or may not be the case. Read the instructions to determine whether or not you need to issue a particular contractor a 1099. If so, you need to deliver to the contractor by January 31st for the previous tax year.

Allec gives two common examples of when you do not have to issue a 1099:

  1. If you paid the contractor entirely on credit cards or through a third-party payment processor such as PayPal.
  2. If you paid their corporation rather than him or her as an individual.

Just remember that a W-9 is a must for all contractors to start work, whereas a 1099 is a case-by-case basis, delivered in January.


3. Create an Independent Contractor Agreement

Although not required, many tax specialists suggest creating an independent contractor agreement to serve as a contract between your business and the independent contractor. Ben Watson, CPA and personal finance expert from DollarSprout.com, justifies why an agreement is a smart idea.

“Having an independent contractor agreement and a Non-Disclosure Agreement (NDA) will clearly identify the terms of your arrangement such as payment schedules, deliverable services or goods, and legal action should the contract be breached by either party,” says Watson.

While you can certainly find a template to start your independent contractor agreement, you should confirm with your tax advisor or legal expert that the agreement covers all necessary points. The good news is, once you have the correct contract and language in place, you can use it for all independent contractors by just tweaking the terms.

4. Keep A Proper Working Relationship With Your Contractor

There’s a fine and often blurry line between an independent contractor and employee. Bill Hughes, CPA and CVA for Business Allies Group LLC, suggests getting the workflow with your independent contractor nailed down so that they or an outside agency can’t later claim they’re an employee.

According to current IRS stipulations, Hughes describes the three categories that underscore contractor classification as it relates to your business’s dealings with the individual:

  • Behavioral control: As the hiring business or “payer,” you have the right to control or direct only the result of the work, not what will be done, and how it will be done. For example, the contractor should set their own hours, use their own tools and materials, and utilize their professional experience instead of your in-house training.
  • Financial control: An independent contractor or “worker” should pay for their own business expenses (travel, licenses, dues, etc.) The worker offers their service to other businesses and is free to seek other opportunities, I.E., only works for your business part-time. Additionally, contractors should be paid a flat fee, as opposed to hourly, commission, or regular wages, which could constitute an employee.
  • Relationship: Workers should not receive benefits, insurance, pension, vacation or sick leave. If there is not a defined end to the service or services provided, the worker is evidence of an employer-employee relationship. If the worker is performing essential/key activities of the business, they are more than likely an employee, not a contractor.

As you can imagine, even when following these outlined instructions for the proper working relationship, there can be a gray area that requires expert consultation.

5. Know That Not All CPAs Are Tax Experts

While you might already have a CPA who does your accounting, not all accountants are tax experts. Especially if you plan to scale, or your first step to growth is hiring an independent contractor, make sure you consult someone well-versed in employment taxes, laws, and regulations.

Abby Eisenkraf, the CEO of Choice Tax Solutions Inc., elaborates on this difference. “Don't make the mistake of assuming all CPAs do taxes. Many do not.” Eisenkraft explains that she has specific credentials. “I am a federally licensed Enrolled Agent, that credential comes from the IRS.” She’s also an Accredited Tax Advisor (ATA) and Accredited Tax Preparer (ATP).

Eisenkraft told us about the wide range of areas that CPAs can specialize in: “I have many CPAs as clients—they may do bookkeeping, render opinions on annual reports, but they don't touch taxes.” When hiring independent contractors, you want a current expert in IRS laws about your industry, state, and business—make sure to find one.

Hire An Independent Contractor Correctly

Don’t risk fines for misclassifying, paying or hiring an independent contractor. Use these tips from the experts to get it right so you can leverage these remote and short-term employees as valuable assets to your business growth.