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Know the Rules For Hiring Contract Labor

January 25, 2011
From the SCORE Reading Room
 
If you’re a SoHo (small office, home office) entrepreneur, you’ve probably built your business in part by working for other companies as an independent contractor (IC). But what happens when your workload puts you in the position of needing additional or specialized help? Before you post a “Help Wanted” sign (literally or figuratively), it’s important to know the rules for hiring and working with contract labor. 

Be Certain of the Terms
As you probably know, an IC is a person contracted to perform services for another business.  The relationship may be for a single project or ongoing as needs arise. The most important distinction is that an IC does not have the legal status of employees. As such, employers do not have to pay the individual’s federal or state payroll taxes, workers compensation premiums, or benefits (e.g., health insurance, vacation and sick leave, etc.). 

Employers are also required to follow the Internal Revenue Services’ procedures for reporting each IC’s compensation. Payments of more than $600 in any year must be reported for income tax purposes. Forms for submitting this information to both the IC and IRS are available at most office supply stores. (Note that a 1099 need not be filed if the IC has incorporated.)

Unfortunately, the distinction between IC and employee varies among state and federal agencies. According to Nolo, a publisher and online resource of legal information for small businesses, “Each is concerned with worker classification for different reasons, and has different biases and practices. Each agency normally makes classification decisions on its own and need not consider what other agencies have done, which means that one agency can find that a worker is an IC while another decides that he or she is an employee. It’s also possible, though rare, for a worker to be deemed an IC in one state and an employee in another.”

Without a clear mutual understanding of this relationship, a SoHo employer risks discovering too late that the IC qualifies to be legally classified as an employee—usually the result of a dispute or the individual’s appeal to a state labor relations agency. Not only must the individual receive appropriate compensation, the SoHo may also face paying back taxes with interest and penalties, and possibly fines.

Plan Ahead
One way to help avoid these problems is to prepare a written independent contractor agreement that fully describes the services to be performed by the IC (including time, location, milestone deadlines and results, etc.), and the IC’s compensation for these services. For certain types of services, the agreement should clearly assign copyright ownership of the IC’s work either to the IC, the SoHo, or the SoHo’s customer.

Nolo also recommends that employers retain all documents that show the individual’s intent to work as a contractor. This includes business cards and stationary, advertising and invoices.  Employers may also consider asking prospective contractors to complete a questionnaire that will help establish the individual as a separate business entity. The questionnaire should request information such as the contractor’s business name (if any), address, phone and structure; professional licenses and affiliations; facilities and contacts of other companies that the individual has served as an IC.

Note that agreements, documentation, and questionnaires may not guarantee that the relationship will be considered employer-contractor. They can, however, demonstrate the intent of both the SoHo and the IC at the outset of the relationship.

For guidance in structuring your SoHo-IC relationships, contact the IRS (www.irs.gov), the U.S. Small Business Administration (www.sba.gov), the U.S. Department of Labor (www.dol.gov), Nolo’s legal publications and software (www.nolo.com), and your state labor relations agency.
Brought to you by SCORE, America’s small business mentors, at www.score.org.
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