Hiring Independent Contractors FAQ

Plain-English answers to questions about hiring independent contractors -- and the differences between contractors and employees.

What is an independent contractor?

Independent contractors (ICs) are people who contract to perform services for others, but don't have the legal status of employees. Because many employment laws and tax rules that cover employees don't apply to ICs, businesses can save time, money, and headaches by hiring ICs instead of employees.

ICs may call themselves by a variety of names -- freelancers, consultants, the self-employed, entrepreneurs, or business owners.

What are the benefits of hiring independent contractors?

Businesses can usually save money by hiring ICs instead of employees. In addition to salaries or other compensation, employers generally have to pay additional expenses for employees, including payroll taxes, insurance premiums, employee benefits, and more.

When you hire ICs instead of employees, you also have reduced exposure to some types of lawsuits, such as those alleging job discrimination or wrongful termination.

Most importantly for many firms, ICs provide a level of flexibility that can't be obtained with employees. You can pay an IC to accomplish only a specific task, allowing your business to get specialized expertise for a short period -- without having to pay for training.

What are the risks of hiring independent contractors?

Despite the advantages, many businesses are wary of using ICs because they have heard about or experienced the consequences of misclassifying as ICs workers who are, legally, employees. And it's true that the consequences can be economically devastating. A business must pay the IRS all back taxes owed, with interest, plus a penalty of 12% to 35% of the tax bill.

Audits by state agencies are even more common than IRS audits. State audits most frequently occur when workers classified as ICs apply for unemployment compensation after their services are terminated.

Another major disadvantage of hiring ICs is that they can sue you for negligence if they are injured on the job. This is something employees normally cannot do, because their work injuries are covered by workers' compensation insurance.

How do government agencies determine whether workers are ICs or employees?

There is no single, clear-cut test for classification. Different legal tests for determining worker status are used by various government agencies, including:

• the Internal Revenue Service
• state unemployment compensation insurance agencies
• state workers' compensation insurance agencies
• state tax departments
• the United States Labor Department, and
• the National Labor Relations Board.

Each of these agencies 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.

To find out the rules these agencies use, see Independent Contractor or Employee: How Government Agencies Make the Call.

Should I ask freelancers and consultants to sign written independent contractor agreements?

Absolutely. Using a written agreement avoids later disputes by providing a written description of the services the IC is to perform, when they are to be performed, and how much the IC will be paid.

A written IC agreement can also help establish that a worker is an independent contractor. Although an agreement by itself is never enough to make a worker an IC, it will help show the IRS and other agencies that both you and the worker intended to create a hiring company-independent contractor relationship, not an employer-employee relationship. IRS training materials state that where all the other factors are evenly balanced, a written IC agreement may tip the scale to the IC side.

But remember, an IC agreement is only useful if you follow it. If you treat a worker like an employee, no contract will undo the damage -- or protect you from government audits.

For help creating a contractor agreement, see Put Your Independent Contractor Agreements in Writing.

How can I prove that the worker I hired is really an independent contractor?

The time to gather evidence of a worker's independent contractor status is before you make a hiring decision -- not after you are audited by a government agency. Protect your company by following these two steps every time you hire an IC:

1. Ask the IC to fill out a questionnaire designed to elicit information showing that the IC is really running an independent business.
2. Require the IC to give you documents that will help you prove that the IC is self-employed.

Who owns intellectual property created by independent contractors?

When you hire an IC to create a work of authorship such as a computer program, written work, artwork, musical work, photographs, or multimedia work, you need to be concerned about copyright ownership.

The copyright laws contain a major trap for unwary hiring companies. The hiring company will not own the copyright to the IC's work unless it obtains a written assignment of copyright ownership. An assignment is simply a transfer of copyright ownership. You should obtain an assignment before the IC starts work. This assignment should be included in the IC agreement.

There are exceptions to this rule. Certain specially commissioned works by ICs are considered to be works for hire, to which the hiring company owns the copyright. However, this rule is not automatic -- you still have to enter into a written agreement explicitly stating that the work is for hire.