Businesses increasingly see the benefits of hiring independent contractors and freelancers, rather than employees. However, there are legal and compliance risks involved. The US Treasury estimated in 2009 that $54 billion of tax revenue was lost through the misclassification of employees as independent contractor. Here we look at how to hire an independent contractor, and how the process differs from the process for hiring employees.
1. The first step when deciding whether to hire an independent contractor is. to check whether this makes business sense and complies with employment and tax laws.
2. There are alternatives to directly hiring an independent contractor including contractor management outsourcing and PEO solutions.
3. When you hire an independent contractor, ensure that there is a process in place for the ongoing management of independent contracts.
How Is Independent Contractor Defined?
Before deciding to hire an independent contractor, it is important to understand exactly what an independent contractor is. The best way of doing so is through contrasting the concept with the most common other form of hired professional, an employee.
While there are some differences in how the terms ‘contractor’ and ’employee’ are defined in different countries, generally, we can define the terms in the following way:
An independent contractor is someone who enters into contracts with client businesses to provide specific services to that client for payment. The relationship is primarily contractual, and the contractor usually runs their own business (whether as a sole proprietor, through a limited company, or some other business entity or structure). Obligations of both parties are limited primarily by the explicit terms of the contract.
An employee enters into a contractor with an employer to provide ongoing service to that employer business. A contract exists, but the relationship is heavily regulated by statute and regulations.
You can read more about the differences between contractors and employees at What’s the Difference between Employees and Independent Contractors?
An independent contractor is at arms length from the client and exists in a business-to-business (B2B) relationship with the client.
Sometimes contractors are not independent in this way, and operate as employees of a staffing agency. These individuals are sometimes referred to as agency contractors, and the process known as contract staffing.
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Hire an Independent Contractor Checklist
If you are considering hiring a contractor, we recommend you take the following steps:
Frequently asked questions
An independent contractor need not be a natural (i.e., living, breathing) person. An independent contractor could be any legal person, including a limited liability company (LLC).
In many cases, it makes sense for businesses to hire independent contractors through a corporate form as matter of due diligence.
A range of personal information, payment, and tax information is usually required to engage an independent contractor. This includes relevant tax numbers, and information for filling necessary tax forms such as form 1099-MISC in the United States.
Self-employment may involved being an independent contractor, but it need not. For example, an individual running their own ecommerce shop, or a food truck, might be self-employed, but not an independent contractor.
No. An independent contractor often has a business classification as a sole proprietor (also called ‘sole trader’) by default. However, the individual contractor can choose to implement operate through another business structure such as a S-Corp, LLC, or a trading trust, if they so choose.
Read more at Independent Contractor versus Sole Proprietor.
The construction industry usually operates via ‘general contractors’, also sometimes called ‘building contractors’ or ‘construction contractors’.
These contractors may be incorporated, or sole proprietorships, and often themselves have multiple employees. It is also common for these contractors to then sub-contract particular tasks (such as plumbing, or roofing) to sub-contractors.
A key difference between an ‘independent contractor’ and a ‘general contractor’, is that an independent contractor usually only contracts out their labor. By contrast a general contractor usually agrees to provide an entire product (such as a house or an apartment building), not just the labor associated with it.
There may be sound business or compliance reasons why a company doesn’t wish to engage an independent contractor, in which case they could consider:
- Hiring employees. Employees can be permanent, part-time, fixed term or ‘zero hours’. Non-permanent options can be useful for businesses that desire flexible human resources
- Engaging a Professional Employer Organization (PEO). A PEO provides an alternative to direct employment or using independent contractors. The PEO employs professionals who then work under the day-to-day management of a client company.
- Contractor management outsourcing (CMO). You still directly engage the independent contractor, but the CMO company takes over all compliance and payment processing tasks for independent contractors.
Many businesses can benefit when they hire an independent contractor. However, before doing so it is important that the business has checked that hiring an independent contractor would make good business sense, and is legally compliant.
Horizons provides independent contractor recruitment and management services, as well as global employment solutions for businesses that seek to employ.
Don’t hesitate to contact us to discuss the best option for your business.