A Comprehensive Guide to Hiring Independent Contractors: What You Need to Know

Businesses need specialized talent to thrive in the current cutthroat competitive environment, especially with the gig economy gaining momentum. 

Employing full-time professionals, however, will drain your resources and shrink your revenue. The popular solution is - hiring contractors independently. 

Independent contractors at work allow you the flexibility to scale up and down as and when required, depending on project size, time, and other crucial factors. 

Moreover, they are a cost-effective way to access a specialized global talent pool without tying you down to commitments associated with full-time employment. 

Hiring an independent contractor requires navigating through legal compliances, classifying contractors and employees accurately, and understanding the finer details of independent contractor agreements. 

Businesses must set project expectations, terms about paying independent contractors, and confidentiality agreements at the onset of projects to avoid hiccups in project execution later on.

This guide details everything you need to know when hiring an independent contractor​, steps to engage them effectively, the advantages of employing them, and more about independent contractor management. Read on.

What is an Independent Contractor?

Independent contractors are self-employed individuals hired for specific tasks or services under a contract. Contrary to popular belief, independent contractors are not limited to short-term projects; they can also be hired for long-term collaborations. 

The main difference between hiring contractors at work and hiring employees is that the former have greater control over their scope of work, operation tools, schedules, and contract duration. Full-time workers do not enjoy these benefits. 

Independent contractors handle their tax obligations from Social Security to Medicare. For employees, these are usually handled by the employer. 

Due to these reasons, the former are commonly referred to as 1099 employees after the IRS Form 1099. 

Form 1099 reports their income instead of the W-2 form used for regular employees. 

Role of Independent Contractors

The role of independent contractors is as varied as the skills required. 

They can be hired for any specialized role, software designer, engineer, architect, etc. They bring flexibility and cost-efficiency to businesses but require clear contracts to define expectations and avoid misclassification risks.

The Benefits and Risks of Hiring Independent Contractors

Hiring independent contractors is a strategic move that can benefit businesses. They can scale their operations or scale them down, access global talent pools minus the liability, and get on-demand services tailored to their needs. 

The process, however, is not without cons altogether. 

Hiring and managing remote contractors effectively requires careful planning and an understanding of their unique advantages and challenges. 

The next section lists the independent contractor pros and cons. 

Pros of Hiring Independent Contractors

Some advantages of hiring an independent contractor are:

• Cost-Effective: Independent contractors save businesses money as they do not require benefits like health insurance, retirement plans, or paid leave. Employers also avoid payroll taxes.
• Flexibility: Businesses can hire and scale their workforce based on demand without long-term commitments. With contractors at work, they can easily address periodic challenges like peak workloads and skill gaps.
• Access to Specialized Skills: Contractors bring niche expertise to specific projects, improving project quality and innovation.
• Global Talent Pool: Hiring and managing remote contractors broadens the geographical scope. Businesses can directly access international skills and perspectives.

Cons of Hiring Independent Contractors

While hiring independent contractors offers flexibility and cost savings, it comes with specific risks and challenges:

• Intellectual Property Concerns: Contractors might claim ownership of the work they produce if there are no clear agreements, leading to disputes or limitations on its use.
• Lack of Control: Contractors work independently and may not follow your company's processes or timelines as strictly as employees would.
• High Turnover: They may leave once a project ends, requiring frequent onboarding and disrupting continuity.
• Misclassification Risks: The consequences of independent contractor misclassification can be heavy, inviting legal penalties and financial repercussions.
• Limited Loyalty: Contractors are less likely to pledge loyalty to your company. This could potentially affect their performance. They might also juggle multiple clients resulting in inconsistent availability.‍
• Potential Quality Variability: Some contractors might not deliver consistent work quality because they have no permanent stake in the company.

Key Differences Between Employees and Independent Contractors

The main difference between employee and independent contractor lies in their work relationship, level of control, and legal obligations. Employees are hired under a formal agreement detailing their employment terms and conditions. 

They are not free to choose their schedules, the scope of their work, work hours, or processes. They must follow the company’s policies and actively contribute to achieving company goals.

An independent contractor, however, can work on their terms as long as they complete the specific task within the time specified in their hiring agreement. 

A simple example is a retail store cashier. He is an employee with set working hours. A freelance graphic designer delivering a project for a company is an independent contractor.

Here's a simple breakdown of the pros and cons of hiring independent contractors vs employees for businesses :

1) Behavioral Control

Employers own the majority of the control over employees. They set employee schedules, supervise their work, and train them for a long-term commitment. 

Moreover, they have complete ownership of the work produced and dictate the tools and processes through which the work is to be completed.  

If hiring an independent contractor, businesses will have no control over the work processes, tools used, or schedules. 

They might even lose ownership over the outcome if it is a case of intellectual property. In some cases, the contractor might claim ownership of the finished product.

2) Financial Control

1. Payment Methods: Employees receive fixed wages. Payment methods may follow monthly, weekly, or bi-weekly schedules. What businesses are paying independent contractors is negotiable and depends on project completion, milestones, or contract terms.
2. Tax Responsibilities: Employers are responsible for employees’ income taxes, Medicare, and Social Security. They might withhold taxes from their paychecks. However, they hold no such liability for independent contractors. Contractors must keep track of their incomes and file their taxes.
3. Profit/Loss Risks: Employees’ salaries are fixed regardless of the company's profits or losses as long as there is job security. Hiring an independent contractor means they will share the risk of both profit and loss incurred by the project.

3) Type of Relationship

1. Contractual Relationships: as the name suggests, independent contractors are bound by legal contracts. Their relationship with the hirer is short-term and ends when the written contract terminates. On the other hand, employees have long-term relationships with contracts detailing their roles, responsibilities, and other aspects of their jobs. 
2. Duration of Work: Employees have ongoing, indefinite employment agreements. Their work terms may include fixed hours, company-provided resources, and long-term roles. 
   
   On the contrary, independent contractors usually have fixed-term or project-specific contracts. Their work duration depends on project scope and deliverables, without the limitation of regular hours or long-term commitments.
3. ‍Project-based Engagement: Contractors work autonomously on projects, delivering results within set timelines, whereas employees do not. Their work is independent of projects.

Legal Considerations and Misclassification Risks

Businesses must practice utmost discretion when classifying workers. The consequences of independent contractor misclassification are significant leading to legal and financial repercussions for businesses. 

It occurs when businesses wrongly classify employees as independent contractors even though they meet the criteria to be categorized as employees under labor laws. 

This means they will be denied employee benefits, like job security, stable income, health coverage, etc.

Some of the things you should know before hiring a foreign independent contractor:

Penalties and Fines

• Missing W-2 Forms: You can be fined $50 for each W-2 form you didn’t file on time.
• Payroll Taxes Not Withheld: If you don’t withhold payroll taxes like FICA properly, you might have to pay:
  • 3% of the employee's wages.
  • 40% of the taxes you should have withheld.
  • 100% of the matching FICA taxes your business owes.

• Unpaid Tax Penalty: If you owe taxes and don’t pay on time, the IRS charges a penalty of 0.5% of the unpaid amount every month. This can go up to 25% of the total owed.

Back Wages and Benefits

• Legal obligation to pay unpaid payroll taxes (Social Security, Medicare, unemployment)
• Liability for unpaid benefits such as retirement contributions and health insurance
• IRS penalties for failure to withhold and remit taxes
• Requirement to compensate for lost wages or benefits

Legal Issues

• Risk of lawsuits due to independent contractor misclassification from employees seeking unpaid wages or overtime
• Class action lawsuits amplify financial and reputational damage
• Tarnished reputation and difficulty in recruiting top talent

Operational Disruptions

• Audits and legal proceedings disrupt core business activities.
• Additional investigations can further hinder productivity.

Reputational Damage

• Violations of labor laws under FLSA harm employer reputation
• Negative publicity and bad press from employees and partners
• Misclassified workers may stop working or discourage others from collaborating

Hidden Costs

• Costs include settlements, back benefits, and long-term trust deficits.
• Increased turnover and damaged morale within the workforce

Global Penalties

• Companies may face back payments of taxes, fines, and benefits in most countries.

Consequences of Misclassification

Misclassification of employees as independent contractors penalties​ are not limited to FLSA violations. Some other consequences:

• Unpaid Payroll Taxes
  Misclassification of employees as independent contractors can result in penalties for failing to withhold federal and state payroll taxes, including Social Security and Medicare contributions.
• I-9 Compliance Issues
  Employers are required to file Form I-9 for all employees to verify work authorization. Misclassified workers lack these records, which can lead to penalties during audits by agencies like ICE or the Department of Labor.
• Unemployment Insurance Penalties
  Misclassification may result in unpaid state unemployment insurance contributions, as payroll records may underreport the number of employees.
• Workers’ Compensation Violations
  Misclassified workers are excluded from state workers’ compensation coverage, leaving employers liable for unpaid premiums and injury claims.
• Benefit Exclusion Liabilities
  Workers classified as independent contractors may miss out on benefits like health insurance, paid leave, or retirement plans. Employers who fail to provide these may face lawsuits or enforcement actions.
• Discrimination Risks
  Misclassified contractors may not receive the protections of federal and state anti-discrimination laws, exposing employers to potential lawsuits.
• Civil and Criminal Liabilities
  Underemployment and tax laws, employers may face a combination of civil lawsuits, back pay penalties, and criminal charges.

IRS Independent Contractor Guidelines

An NELP analysis found that 10-30% of employees faced independent contractor misclassification. Businesses can avoid misclassification of employees as independent contractors penalties by following the IRS independent contractor guidelines. 

This will save them from paying heavy fines or facing expensive legal penalties. Here’s the IRS checklist for businesses:

• Employers must file Form 1099-NEC to report payments to independent contractors earning $600 or more in a tax year.
• To ascertain a worker’s status, businesses or individuals can file Form SS-8 to request an IRS determination. 
• Independent contractors pay their taxes directly, including self-employment tax, through estimated quarterly payments.

The IRS used a 20-factor test to help businesses categorize workers as employees or independent contractors. In 2019, this was substituted by the Common Law/Three-Pronged/Control Test.

State-Specific Regulations

State laws for hiring independent contractors vary significantly from federal guidelines, so businesses must comply with both. While federal guidelines like the IRS Common Law Rules apply nationwide, states may have stricter tests. Here’s a watchlist for businesses:

California

• Proposition 22: Rideshare companies like Uber and Lyft can classify drivers as independent contractors. However, specific labor and wage policies are required for app-based drivers.
• Save Local Journalism Act: Newspaper publishers were allowed an additional year to classify newspaper carriers as independent contractors. This extension expired on January 1, 2022.

Iowa

• SB 2296: Effective July 1, 2021, workers operating certain vehicles are classified as independent contractors instead of employees.

Louisiana

• A new definition of "employee" was added, stating an employee performs services under employer control or uses employer-provided tools and supplies.

Virginia

• HB 1407: Misclassifying employees as independent contractors is illegal under the IRS common law test.
• Penalties: $1,000 per misclassified employee (first offense) and up to $5,000 for subsequent violations. This law has been in effect since January 1, 2021.

Best Practices for Hiring Independent Contractors

Now that you have an idea of what you need for onboarding an independent contractor let’s dive into the best practices to make the process easier:

• Define the scope of work, deliverables, and deadlines in detail. Be specific and leave no room for ambiguity.
• Post your job listing in the right place. Avoid posting it in the career section. Use online marketplaces to gain greater exposure.
• Review resumes by skill.
• Select a standard set of questions for the interview process to get a comparative idea about applicants. Include questions based on their portfolio, too.
• Maintain a timeline for the hiring process. Respond immediately to applications and close the hiring to filter out the best contractors.
• Follow-up after the first round of interviews to retain the attention of skilled contractors. Otherwise, you might end up losing talented contractors.

Background Checks and Vetting Process

Here are the steps to vet credible and skilled contractors:

• Conduct independent contractor background checks.
• Verify references produced by the contractor to confirm their reliability, quality of work, and professionalism.
• Assess contractor skills by conducting interviews.

Drafting Clear Contracts

Any ambiguity in contracts for hiring independent contractors can leave businesses open to legal action and other negative consequences. Here’s what your legal drafts must include:

• Scope of work
• Duration of project
• Project requirements
• Paying independent contractors (mode and time of payment, whether upon project completion), business expenses, and limits or restrictions, if any.
• Specify who owns the rights to the Intellectual Property created.
• An NDA to keep confidential information private, if applicable
• Insurance requirements for the contractor depend on the nature of the project.
• Specify laws to resolve disputes in case they arise.

Documenting Independent Contractor Status

Proper documentation is essential to ensure compliance and smooth business operations when managing and hiring independent contractors. Here are some key elements to track:

1. Invoices for payments made to contractors.
2. W-9 form for reporting income to the IRS (for US contractors).
3. Contractors should maintain proof of their business operations, such as business licenses, contracts, or insurance.

Paying Independent Contractors Effectively

There are various ways you can adopt to pay your hired contractors. However, each should be legally compliant. 

You must exercise greater discretion when engaging with cross-border contractors since the employment laws might change depending on the contractor’s country of operation.

1. Bank transfer: This is a secure and direct method of depositing funds into the contractor's bank account. It is best for local payments or recurring transfers.
2. Cheques: Traditional payment method; helpful in maintaining a paper trail but slower than electronic options.
3. Online payment platforms like PayPal, Wise, Xoom, and SWIFT: Ideal for global payments with lower fees and fast transactions.
4. International wire transfers (for example, via Western Union): Suitable for contractors in remote areas without digital banking access. Offers high reach but may involve higher fees.‍
5. AOR: Essential for tax and compliance, ensuring the contractor confirms payment receipt.

How Skuad Can Help

Skuad makes managing and paying global contractors effortless. With its unified platform, you can simplify invoicing, ensure compliant payments, and manage contractors seamlessly across 160+ countries. 

600+ companies have collaborated with Skuad for AOR for hassle-free international operation and expansion.

Book your demo with Skuad today!

FAQs

1. What are the rules for a 1099 employee?

1099 employees are self-employed. Hence, they must file their own taxes under Form 1099, and maintain their licenses and insurance from Social Security to health.

2. Do I need an EIN if I hire an independent contractor?

You don’t need an EIN to hire an independent contractor specifically. As a business owner, you can use your Social Security Number (SSN) for tax reporting purposes, such as when filing Form 1099-NEC for payments made to the contractor. 

3. What are the benefits of hiring an independent contractor?

Hiring independent contractors allows greater flexibility for scaling operations, reduces liabilities, saves time with less time required for supervision and training, and reduces expenses, greater turnover, less resources required. 

4. Can a US company hire a foreign independent contractor?

Yes, a United States company can hire a foreign independent contractor, but it must comply with tax and legal requirements. This includes obtaining a completed IRS Form W-8BEN from the contractor and adhering to both US and local labor laws where the contractor resides.

5. Do I have to prepare a 1099-NEC for a foreign contractor?

You have to prepare a 1099-NEC for a foreign contractor only if the payment exceeds $600 during a year.

6. How to pay international independent contractors?

You can pay international independent contractors using international wire transfers, cryptocurrency, dedicated platforms like Wise or Deel, and online platforms like PayPal.