The benefits to hiring contract labor over employees can be significant — especially for small businesses. And many workers prefer this arrangement as well because of potential tax benefits. But contract labor is not always the best option and also comes with many considerations to make sure the working arrangement is executed correctly. Whether you already engage with contract labor or it is something new that you are considering, here is a brief rundown of the things every business owner should know when hiring for contracted work.
Hiring Contract Labor vs. Employees
Determining contract labor by legal standards
First of all, you need to be aware that deeming someone contract labor as opposed to an employee is not as simple as filling out different forms. If a worker falls into the employee category based on certain criteria, you and the worker can find yourselves vulnerable to massive expenses by way of penalties and back taxes. So how can you be assured that your contract labor is in fact contract labor by legal standards? Consider the following:
Who’s the boss? While the worker is performing work for you, who has the ultimate say over where, when and how the work is completed? If you dictate that work be done a certain way, during specific hours and from a specific location, it is likely that this person would be considered an employee instead of contract labor. Self-employed workers typically have the autonomy over those decisions. In this same vein, depending on the type of work being performed, the “degree of instruction” provided to the worker can come into play. And if you are evaluating performance of contract labor in any way, it should be strictly the end result that is evaluated rather than the nuts and bolts of how the work is performed.
Who controls the purse strings? Again, another factor that can separate contract labor from employees is various factors relating to finances. For instance, does the worker invest in their own equipment? While it is typical in some industries like construction for employees to buy their own tools, in other fields like marketing, an employee is not typically expected to purchase their own computer. Unfortunately, there are no specific guidelines that apply to this aspect, but familiarity with common industry practices is helpful in deciding whether or not this points to contract labor or an employee.
Similarly, most independent contractors work for flat fees for work completed. In some industries, like the legal industry, independent contractors may incur hourly fees.
Perhaps the most significant financial criteria to consider is whether or not there is a potential for the worker to incur a financial loss as the result of the work they are doing. If a worker is incurring unreimbursed expenses to complete a project, there is a potential that money could be lost over the course of the project — this would imply that the worker qualifies as contract labor.
Relationship talk: When determining whether you and a worker have a employer-employee relationship or a relationship typical of a business and contract labor, there are a few more considerations recommended by the Internal Revenue Service (IRS).
Surprisingly, written contracts do not factor into this. While paperwork may state that someone is contract labor or an employee, the determination ultimately falls to the other criteria discussed in this article.
If you provide benefits like health coverage or a pension to a worker, they would likely be considered an employee. Though it must be mentioned that a lack of benefits does not automatically mean that a worker is considered contract labor.
Hiring a worker with the intent to work with them forever or indefinitely is also considered evidence of an employer-employee relationship. Again, this will depend on the industry. But even for ongoing functions like marketing where you may hire contract labor for long periods of time, consider making terms of the contract for year-long periods to then be reassessed at the end of the term.
And if a worker is conducting work deemed to be “key activity” to your business, it would also imply that they are an employee. The IRS offers the example of a lawn firm that hires an attorney to represent clients. This would likely indicate an employer-employee relationship because the law firm would be likely to present the attorney’s work as its own.
Applicable paperwork for contract labor
You might already know that you need to get a W-9 from contract labor before beginning work. But some other paperwork to get out of the way includes:
- A resume or other documentation of qualifications — this will be helpful in a variety of context should (God forbid) something go wrong with the relationship and you find that you need to pursue legal action.
- A nondisclosure agreement — this is dependent on the type of work being done, but companies should err on the side of getting nondisclosure agreements from any contract labor who may, over the course of their work with the company, become privy to any proprietary or sensitive information.
- A written contract — even though the contract is not enough on its own to prove that someone is contract labor and not an employee, a written contract is still incredibly useful in outlining all of the expectations you and the independent worker have for the project they will be completing, including the scope of work, ownership of work produced and timing of payments and amounts.
Hopefully this article has left you feeling incredibly well-versed on the realities of hiring contractors. On the other hand, if you found that we didn’t cover a specific questions you have or if the ambiguous nature of some the the contract labor criteria have left you with more questions, give us a call. We would be happy to discuss your specific situation and give you any advice for how to proceed in hiring contract labor.