Building Your Business Business Taxes Hiring and Paying an Independent Contractor Taxes, Contractor Agreements, Backup Withholding By Jean Murray Updated on February 18, 2021 In This Article View All In This Article Check Worker Status Before Hiring What Is an Independent Contractor? Form W-9 for Independent Contractors New Hire Paperwork for an Independent Contractor Check Credentials Before Hiring an Independent Contractor Paying an Independent Contractor Independent Contractors and Tax Reporting Backup Withholding From an Independent Contractor Create a Contract for Independent Contractor Many small business owners prefer to work with independent contractors rather than hiring employees. Benefits of hiring independent contractors include: As the hiring employer, there are still some things you must do to hire and start paying that independent contractor. Flexibility in being able to vary hours worked, or paying by project, and not having to pay when work isn't availableOutsourcingnon-essential tasks, like IT and maintenance, so you don't have to set up a new department within your companyBeing able to end the relationship easily without the paperwork and potential problems that go with firing an employeeNot having to pay Social Security and Medicare tax on contractor income.Less hiring paperwork, fewer reports, and fewer payments to the IRS Check Independent Contractor Status Before Hiring Thomas Barwick/Getty Images Before you hire and start paying an independent contractor, make sure that this worker is truly an independent contractor and not an employee. Misclassifying an employee as an IC can result in state and federal fines and penalties. Several federal and state agencies have tests and requirements for independent contractor status, including the IRS, the Department of Labor, and state employment agencies. Here's a quick review of the requirements for these entities: IRS Classification For various reasons (mostly to do with payroll taxes), the IRS is concerned that workers are appropriately classified as either independent contractors or employees. The IRS considers that worker to be an employee unless you can prove otherwise. The IRS determines the status of workers on a case-by-case basis, and it looks at behavioral, financial, and control factors to determine status. If you are unclear about the status of people who work for your business, you can request a determination from the IRS. Department of Labor Classification The Department of Labor (DOL) looks at independent contractor-vs.-employee status as in relation to the primary wage and hour law, the Fair Labor Standards Act. The DOL says that if an "employment relationship" is present between the worker and the employer, the worker is covered under the provisions of the FLSA for several purposes, including: Minimum wagesOvertime payYouth workers There's no single rule or test that can be used to determine whether an employment relationship exists. It's the total activity or situation which controls. The existence of an employment contract doesn't, the place where the work is performed, or whether the person must be licensed by a state or locality. State Classification States classify workers to determine their eligibility for state programs, especially unemployment insurance and worker's compensation. Some state requirements are more restrictive than those of the IRS or DOL. For example, California and some other states use a three-factor ABC test in which all three factors must be met for the person to be considered an independent contractor. Note The IRS, Department of Labor, and individual states have different requirements and purposes for independent contractor status. An individual may be classified as an independent contractor for one purpose under one agency and as an employee for another purpose. What Is an Independent Contractor? Jon Schulte / Getty Images An independent contractor is someone who does work for another person or company. Independent contractors are business owners who are in a trade, business, or profession and who offer their services to the general public. Someone is an independent contractor if the person paying them can only control or direct the result of the work. An example of an independent contractor is a cleaning service. The service comes into your office to do work, but the cleaning service workers are not employees of your company. You can tell them which offices to clean and when you want them to clean, but you can't tell them what cleaning supplies to use or how to run the vacuum cleaner. Form W-9 for Independent Contractors Thomas Barwick/Getty Images The most important document you must get from an independent contractor is Form W-9. The W-9 form serves the same purpose as a W-4 form for newly-hired employees. Anyone you hire as an independent contractor must complete and sign this form before they begin work for your business. The person must include a tax ID number (social security number, or employer ID (EIN) on the form. New Hire Paperwork for an Independent Contractor Peopleimages/Getty Images In addition to the W-9 form you'll need specific new hire paperwork for each independent contractor you hire: The person's resume or professional qualifications, for your own protection and to verify in case of an audit by a federal, state, or local agency. A contract, for even the most simple independent contractor relationship. Check Credentials Before Hiring an Independent Contractor Westend61 / Getty Images In the same manner, as you check references for an employee, be sure you check the credentials of a contractor before hire. You might also want to do a background check on all prospective contractors. For example, if you are considering hiring a bookkeeping service, make sure this person has no felony convictions. Some jobs require background checks. For example, state laws require background checks for anyone working with children, the elderly, or disabled people. If the independent contractor is organized as a business, you should do a check with the Better Business Bureau to make sure no complaints have been filed against this business. Don't forget the tried-and-true web search, including reviews of the business. Paying an Independent Contractor Hero Images/Getty Images Paying an independent contractor is pretty simple. You can pay by the hour or by the job. In most situations, you don't have to withhold income taxes or Social Security/Medicare taxes from independent contractor income. You also don't have to pay unemployment taxes on independent contractors.Independent contractors are responsible for paying their own income taxes and self-employment taxes (for Social Security/Medicare). Independent Contractors and Tax Reporting Bob Travaglione FoToEdge/Getty Images You must keep track of payments you make to independent contractors each year and report the total payments to the IRS. For each independent contractor you paid $600 or more during the year, you must report the total amount paid on Form 1099-NEC. This form includes information about your payments to the independent contractor, but it doesn't usually include tax withholding unless the person is subject to backup withholding (explained below). You must send the 1099-NEC form: To each independent contractor no later than January 31 of the following year, and To the IRS no later than January 31, using either mail or electronic filing. Backup Withholding From an Independent Contractor David Burton/Getty Images In most circumstances, you do not need to withhold income taxes from the payments you make to independent contractors. But there are some exceptions: If you receive a backup withholding notice from the IRS, you must withhold income taxes on payments to the independent contractor. Usually, the IRS will send this notice if the taxpayer identification number (Social Security Number, Employer ID Number, or Individual Taxpayer ID Number) of the independent contractor is incorrect or missing. You don't have to do anything until you receive the backup withholding notice from the IRS. Then follow the specific instructions on the notice and begin withholding income taxes from the independent contractor immediately at the backup withholding rate of 24%. Create a Contract for Independent Contractor Hero Images / Getty Images In every case, before you hire an independent contractor, create an agreement and get it signed by the contractor. The agreement should include details about the requirements of the contractor, pay rates, and sections about non-competition and confidentiality. If the contractor is creating work to be copyrighted, trademarked, or patented, the ownership of this property should be made clear, including a work-for-hire clause in the contract. Finally, be sure to include a statement about independent contractor status; that is, that the person is not an employee. Was this page helpful? Thanks for your feedback! Tell us why! Other Submit Sources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. IRS. "Independent Contractor (Self-Employed) or Employee?" Accessed May 10, 2021 California. Labor & Workforce Development Agency. "ABC Test." Accessed May 10, 2021. IRS. "Independent Contractor Defined." Accessed May 10, 2021. Cornell Legal Information Institute. "Independent Contractor." Accessed May 10, 2021. IRS. "Instructions for Forms 1099-MISC and 1099-NEC." Page 7. Accessed May 10, 2021. IRS. "Instructions for Forms 1099-MISC and 1099-NEC." Page 1. Accessed May 10, 2021. IRS. "Backup Withholding." Accessed May 10, 2021. U.C. Berkeley School of Law. "Sample independent Contractor Agreement (WORD)." Accessed May 10 2021.