Hiring Independent Contractors: What Rules You Need to Know

In 2019, almost 30% of Americans were self-employed, and this percentage is set to grow to 50% by 2027. Contract workers are likely to become the norm in most businesses. And it’s not surprising why. Hiring independent contractors can help businesses reduce costs while accomplishing critical tasks. Since contract workers don’t require health insurance or workers’ compensation, the savings can be substantial, especially for a small business.

Hiring independent contracts can help businesses cut costs.

But for Human Resource professionals, it can be a challenge to understand the hiring and onboarding process for a freelancer. Unlike regular employees, freelance workers have a completely different mindset and paperwork requirements.

Hiring an independent contractor

A freelancer is not a W-2 employee. Instead, an HR professional or small business owner should use an IRS form W-9 for hiring contractors, and subsequently, send a 1099 at the end of the fiscal year that lists what you’ve paid the freelancer.

A 1099 form requires the following information from a contractor:

• Name
• Social Security Number, EIN, or ITIN
• Current address
• Date of birth
• Tax classification, name if they are a sole proprietor, partnership, or corporation

Whether you hire a domestic or international contractor, you do not need to worry about withholding taxes. The freelancer is in charge of filing their own income tax. You only need to track the payments you are making to each individual freelancer. This information will go into their 1099 form, which will be mailed to the IRS.

You don’t have to withhold taxes when paying independent contractors — they pay their own taxes.

That said, there’s a lot of concern about who can be classified as an independent contractor. This has led to a split in the classification system. Many states still use the IRS Common Law test, but 33 others, such as California, use the modified version of the 1930’s ABC Test.

Here is the difference between the two:

IRS Common Law

The IRS Common Law classification system considers several different key differences between a regular full-time employee and an independent contractor. However, these boil down to three main differentiators:

• Behavioral – Typically, a business controls what an employee does and how they carry out their tasks. They manage their time, provide materials, and employees must abide by all company policies. Independent contractors, however, have few, if any controls.
• Financial – A regular employee is paid by the company, and their employer dictates how and when they will be paid. Typically, the employer is also responsible for supplying work materials, withholding taxes, and providing employee benefits. In contrast, contract workers pay for their own materials, can set their own payment terms, and pay a self-employment tax on their own.
• Relationship – Finally, the working relationship between the employer and their employee is taken into account. WIll the worker still be employed after finishing their current project? If the answer is no, they may be an independent contractor. Freelance workers generally work on a contract basis or project basis.

Independent contractor status under this standard does not require every box to be checked.

For example, a contractor might pay their own taxes, require the employer to sign a contract, leave the company after a project is completed, and work in their own time. But, the contractor may also require the employer to cover the cost of materials. Or, conversely, the employer may want the freelancer to use a company laptop for security reasons. But since most of the criteria are met, the worker can be considered a contractor, not a regular employee.

ABC Test

While the ABC test dates back to the 1930s, it has become a hot topic over the past few years. Many believe that companies like Uber misclassify employees as independent contractors using the IRS Common Law standards. Why would a business attempt this? Simply, to reduce costs.

Several states have long-implemented a version of the ABC test, but California made headlines with its strict inclusion of the standard after implementing AB5, a law that reclassified millions of freelancers as employees. Since it has been enacted, several amendments and expectations have been made for certain industries that rely heavily on independent contractors.

The ABC is not part of federal law, but it may become a central point in labor and employment law.

So, how does the ABC test work? Like the IRS Common Law test, it uses three main criteria to determine classification. For a worker to be considered an independent contractor, they must:

• Be free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work
• Perform work that is outside the usual course of the hiring entity’s business, and
• Customarily engage in an independently established trade, occupation, or business of the same nature as that involved in the work performed.

To be considered an independent contractor, an individual must meet all three criteria.

Currently, the ABC test is not a part of federal law. But there are proposed bills to make it a central point in labor law and employment law.

The HR guide to hiring independent contractors

With the rise of remote work and ever-shifting classification laws, hiring independent contractors can seem like a headache. But as more workers dive into self-employment, contractors will become a critical part of the workforce across industries.

To learn more about how you can hire an independent contractor without stressing over compliance, check out our guide for HR managers on hiring freelancers.