Contractors are a great way to get specific projects done without hiring a permanent employee or having a current employee without the expertise to do it. The question does come up of how to pay and manage independent contractors. Before you hire an independent contractor, take a look at this ultimate guide on paying contractors.
What Qualifies as an Independent Contractor
The first step, and one that is more difficult than you may expect, is determining whether a worker qualifies as an independent contractor. You’ll have to determine this on a case-by-case basis.
To make this simpler, the IRS has put out a test that you can find here. This is called the 20-Factor Test and consists of 20 yes-or-no questions that can help you make the determination that a worker is independent enough to be considered a contractor, or you have enough control that they are considered an employee. You can get an in-depth manual for that test through your local IRS center. A high number of “yes” answers on this test means that the worker is most likely an independent contractor, while many “no” answers would mean that they very well may be an employee.
Keep in mind that this isn’t a foolproof system. The best way to know for sure is by pursuing an IRS ruling to get an official determination.
Contractor Payment Agreement
While a verbal contract is just as valid as a written contract, it is still good to get as many details as possible in writing to avoid any miscommunications. Here are some of the most important pieces of information to include:
- How much the payment will be and whether the payment will be hourly or by the job.
- How often a payment would be due if this is a recurring service being provided.
- If there is a minimum amount that will be due. This is only applicable to those being paid hourly.
- Any additional fees that may arise.
- For by the job pay, any milestones or deadlines that will result in payment when met.
- What reports about the job will be due and when.
- Whether subcontractors will be allowed.
- What will happen if the work is not completed in time.
- What will happen if the payments are not made on time.
- What will happen if the work that is done is not done correctly.
Be sure to determine all of this and have it agreed upon before any work gets done. It is much harder to make a determination about these terms after any amount of work has been completed.
Withholding Income for Contractors
For most contractors, you don’t have to withhold income when filing payroll taxes. Independent contractors will pay the full amount when filing their taxes.
While this is the case for almost every independent contractor, there are a few exceptions. If you have workers that qualify as independent contractors but fall under certain conditions, they should be treated as employees. These are called statutory employees. You can find those conditions here.
You may have to have backup withholdings in place. This will happen when the IRS directs you through a backup withholding notice as a result of incorrect information on the W-9, specifically the taxpayer ID. When this happens you will have to withhold the backup withholding rate of 24% by filing Form 945.