Small business owners work—a lot. A recent survey found that almost one-third of owners work more than 50 hours per week, and 86 percent work on weekends.
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It doesn’t have to be that way.
Use this article to speed through each step of the process when hiring a contractor so you can quickly bring on the best help for where your business is at.
What to do before hiring a contractor
When you bring on a contractor, you don’t want any surprises. From following employment tax law to classifying your workers correctly, here are some steps you’ll want to take before bringing a contractor on board.
1. Figure out if you need a federal employer identification number (EIN)
Before hiring anyone, you need to know whether your business is registered as an actual business.
To determine whether you need an employer ID number, first think about the type of entity you have (or want to form if you haven’t formed one already). Most small businesses incorporate to receive liability protection, but there are other options available.
However, you’ll need to get an EIN if you own one of those entities and want to:
- Change your business structure
- Hire employees
- File for bankruptcy
- Inherit or purchase an existing business and convert it to a sole prop
- Offer a Keogh or Solo 401(k) plan
You’ll also need to get an EIN if you own any other type of entity, like a multiple-member LLC, partnership, or corporation). Here’s how to get an EIN.
Unsure of which entity to choose? Here’s a (very) quick rundown of the different business entity types that exist:
- S Corporation, or S Corp: An S Corp is a popular choice for many businesses. S Corps can provide significant tax savings but are generally more complicated legally.
- C Corporation, or C Corp: A C Corp can be subject to “double taxation,” meaning taxation of the individual as well as the entity, which often makes them unpopular with small business owners.
- Partnership: A Partnership is formed when at least two people are in complete control of the business, and both share in the profits. Each partner is personally liable for the company’s financial situation. Even if you don’t register your partnership or file paperwork, if your business meets this definition then you may be treated as a partnership.
- Sole Proprietorship, or Sole Prop: A Sole Prop is one of the most popular entities because it’s easy to start and gives the owner total control. As a Sole Prop, you are personally responsible for all financial obligations of your company.
- Limited Liability Corporation, or LLC: An LLC is a lightweight alternative to incorporating your business. It helps you avoid double taxation and is a more straightforward type of entity.
2. Become compliant with your state departments
If you’re a corporation, LLC, partnership, or nonprofit, your next step after obtaining an EIN is to register your business with your state.
3. Learn how to classify your team
The difference between contractors and employees can be blurry. That’s why one of the most important legalities to understand is how to classify your workers accurately.
Any misstep could be bad for your worker—and it could sock you with steep fines and penalties too. The IRS considers all workers to be employees unless you can prove otherwise and employs a battery of tests and considerations, which vary by state, to make sure the person actually qualifies as an independent contractor. So pay close attention
How to tell if your worker is a contractor:
If you answer “yes” to most of these questions, your worker is most likely a contractor.
- Is your worker being hired for a temporary project?
- Can your worker choose where and when the work is performed?
- Does your worker use their own materials for the work performed?
- Is your worker paid a flat fee or hourly rate that they invoice to your company?
What does the ABC Test mean for businesses in California?
In 2018, there was a Supreme Court case in California (Dynamex Operations West, Inc. v. Superior Court of Los Angeles County) that made it harder for California businesses to classify workers as independent contractors. The case created a checklist, called the ABC Test, that employers can use to help them classify workers.
This brings two key changes for businesses in California:
(1) Employers can’t hire contractors to do work that is a core part of what their business does, and
(2) The contractor needs to actually have an independent trade, occupation, or business in the industry in which you hire them.
Of course, there are exceptions to every rule. For example, California recently passed Proposition 22, which exempts app-based transportation companies like Lyft and Uber from classifying drivers as employees. Even though some drivers may meet the criteria for employee status, the law allows them to be classified as independent contractors.
Still unclear about where your worker fits in? Check out the IRS’s classification guide.
You can also fill out IRS Form SS-8 to receive a final call. Make sure to do this before you bring your contractor on board, so as not to put your business at risk.
It could take at least six months to get an answer (which is why it’s not the most popular option), but it will help you get closer to the right classification if you’re particularly concerned about a specific contractor.
4. Write the job description and define the relationship
One of the first relationship milestones: defining what you are. Exploring each of these questions will help you zero in on who you’re looking for and how you want to work with them.
- Can you work with this person on a project-to-project basis?
- Is this someone you want to eventually join full-time?
- Do they have to be local?
- Can they work from your office?
As you write your job description, weave in these details to help you find the best possible candidate.
5. Create an independent contractor agreement
Before you hire your contractor, you want to create an independent contractor agreement, which is a legal contract that explains your business relationship.
Why? Because it’s important for all parties to get on the same page so time and resources aren’t wasted—and to minimize legal issues should your relationship get messy.
We recommend that a lawyer draw this document up for you, but make sure you include the following in the agreement:
An overview of the relationship
- Project description
- Timeline and deadlines
- Equipment your freelancer can use
- Offices your freelancer can work from
- Standards that you’ll use to evaluate their work
- Any other specifics
This includes your rights involving intellectual property, like software, graphics, or other work that they create.
If needed, this is the spot where you explain that your contractor isn’t allowed to share anything tied to the work they’re doing for your business.
Payment and billing terms
This is where you explain the pay rate, and how and when your contractor will be paid.
This section spells out (1) how many days notice each party has to give before ending the relationship, and (2) under what grounds each party can terminate the relationship, like failure to perform up to the standards explained in the overview of the relationship.
The termination clause is especially important for small business owners because it allows you to end the relationship immediately—without having a notice period. Imagine hiring someone to write ten emails for you and then they only write one. Technically, they wrote the email, but unless your contract explicitly says what your performance standards are, it’s hard to say whether or not the contract has been breached.
Once your freelancer starts, follow the steps below to help minimize penalties and errors.
6. Run through this checklist of legal to-dos
There are a couple independent contractor tax forms you’ll want to familiarize yourself with once your contractor accepts the gig.
Ask them to fill out Form W-9 (or Form W8-BEN if they’re an international resident or citizen)
Form W-9 verifies your freelancer’s name, address, and Taxpayer Identification Number (TIN).
The W-9 doesn’t need to get sent anywhere, but you’re required to keep it on file for a minimum of four years. While reviewing your contractor’s W-9, make sure they exempt themselves from withholding, since they should be filing taxes on their own.
Fill out For 1099-NEC
If you’ve paid your freelancer at least $600 this year, you did not use a credit card or third party payment platform (like PayPal) to process their invoices, and they did not check a box indicating that they run an S corp or C corp on # 3 of their W-9—then you’ll need to complete Form 1099-NEC. This form reports how much they earned working for you. Both you and your contractor will need this form for filling out your taxes, so don’t lose it.
- Send Copy A of the 1099-NEC to the IRS and Copy B to your contractor by January 31. If the 31st falls on a weekend, then it’ll be due by the following Monday.
- Check with your CPA to ensure compliance at the state level. State laws vary and there’s a chance you may also have to file any 1099s with your state.
7. Run through this checklist of best practices
Once you’ve nailed down the initial legal requirements, there are some extra things you can do to ensure that your contractor relationship goes as smoothly as possible. Here are a few tricks of the trade that’ll help you stay compliant (and sane).
Ask for invoices
Only pay your contractor once they’ve sent an invoice your way. Save each invoice for your records, and don’t accept any expense reports unless you’ve already agreed to them. All business expenses are the responsibility of your freelancer unless your agreement explicitly says otherwise.
Consider adding your freelancer to payroll
Depending on how long your relationship will last, it may be easier to add your contractor directly to your company’s payroll—even if they’re not full-time. Some payroll services like Gusto can automatically file 1099s and send the forms to freelancers so you don’t have to deal with it. Here are more details on how to pay independent contractors.
Did you know that if you hire independent contractors, you may be more likely to be audited? This is why it’s important to keep records carefully. Hold on to every single document related to your freelancer (and, again, make sure they’re classified correctly). Keep track of contracts, invoices, and proofs of payment, if they’re not done electronically. If you use Gusto, your proofs of payment will automatically be stored.
Enroll in the Electronic Federal Tax Payment System (EFTPS)
Enrolling in the EFTPS will make it easier to pay taxes to the IRS.
Here are some useful resources that will help you get your freelancers up and running. As always, you should talk to your lawyer if you have questions about these forms.
Templates and legal resources
For broad templates and legal resources, check out these sites:
Job description tips
A good job description is critical for finding the right freelancer. For tips on writing the perfect job description, check out this guide and template.
You may want to require contractors to sign non-disclosure agreements (NDAs) to protect non-public business information. Figure out whether a one-way or mutual NDA makes the most sense, and check out some samples below:
Independent contractor agreements
When you hire a contractor, it’s important to clarify the role, compensation, and other legal ramifications of the position (including scope, payment terms, and ownership of work product). These resources will help you generate those documents:
- Berkeley Law Sample Independent Contractor Agreement
- Docracy Independent Contractor Agreement Template
- Entrepreneur Business Forms and Templates Independent Contractor Agreement
Spend more of your energy on growing your business by hiring an independent contractor.
All the rules and paperwork involved may be intimidating at first, but once you know how to handle them, it’ll free you up from the tasks that are bringing you down.
This post was originally published on November 11, 2018.