We’ve been talking about contracts this week. Yesterday we talked about how you move from a simple conversation to a binding agreement. Today, I want to talk specifically about independent contractor agreements and why it’s more important than ever to make sure those agreements are in writing.
Independent contractor relationships can be empowering and financially beneficial for both the contractor and the business owner.
For a business owner, having independent contractors instead of employees means a significant savings. You don’t have payroll tax, unemployment insurance or workers compensation to deal with. Nor do you have severance pay, unions, or disciplinary proceedings. You hire someone to provide a service to your business. That person does or doesn’t provide the service, and you pay or don’t pay. It’s simple.
From a contractor’s perspective, it’s a pretty good deal, too. You work when you want and how you want. No desk, no lunch hour, no supervisor watching you – no punching a clock. One of the fundamentals of a good relationship between business and contractor is the lack of oversight. Your goal is to produce the required result, on or before a certain date. How and when that happens is your business.
When you’re a contractor, you aren’t an employee. You’re a business owner too, and that means all those tax deductions, savings, credits and breaks that are available to the business, are available to your business, too! Can you be fired? No. Your contract can be terminated if you don’t perform and deliver the result, but you can’t be fired. Plus, you aren’t bound to just providing service to that one business. You can spread the love around and work with as many other businesses as you want. And, don’t forget, the business is bound by that contract, too. If the business doesn’t hold up its part of the deal (i.e., you don’t get paid), you have a right to sue them. The contract is a 2-way street.
Everything sounds great, until the IRS comes along to take a closer look. From their perspective, independent contractor relationships are okay, but ONLY if all of the rules are followed. Because their focus is taxes, their biggest rule of all is making sure that payroll or self-employment taxes are being paid. Yet many contractors forget this part. They take the payment from the business and forget or don’t both making their own payroll or self-employment tax contributions. So many contractors have done this in the past that it’s often easier for the IRS to try and reclassify contractors as workers, instead of chasing them down for unpaid taxes. If the IRS can make a reclassification argument stick, it can force the business to come up with all the missing payroll tax instead.
As a business owner, your very first line of defense is a written contract. The contract should clearly define the nature of your relationship with the contractor. It absolutely MUST have a plain-language clause stating that the contractor knows and understands they are not an employee, you are NOT withholding payroll tax on their behalf, and THEY are responsible for making those payments to the IRS.
It’s also a good idea for business owners to insist that they deal only with contractors who operate through their own businesses. It’s a lot harder for John Doe to say “I didn’t know I was a contractor, I thought I was an employee!” when the written agreement is between ABC Corporation and John Doe Service-for-Hire, Inc.
When you pick up your copy of our product, 10 Things You Must Know to Write a Legal Contract, you’ll find more discussion on independent contractor issues. Plus you’ll get a template, as one of the sample contracts we’ve included.
Is a contract all you need? Unfortunately, the answer is no. The IRS takes a look at other factors as well, when it is making a worker classification ruling. But that written contract is a very good first step. Without it, you, as a business owner, are more vulnerable than you need to be.