Important Forms and Documents When Hiring Contractors

As a business owner, there may come a time when you need to hire independent contractors. Independent contractors (IC) are individuals businesses can hire under contract to help them complete a time-sensitive task or project. Using these nonemployees provides a lot of benefits, but it helps to understand the expectations and implications that come with hiring ICs and ensuring you’re using the correct independent contractor forms.

 

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Key differences between an employee and an independent contractor

A couple of key differences between employees and independent contractors can make them attractive options for businesses. First, they use their own resources. In some cases, if the independent contractor has to come into the office, they would need basic accommodations, like a desk and chair, but in many cases they work remotely, using their own data and equipment.

 

This ties into the second difference, which is that ICs may not need much training, or any at all. In ideal cases, the independent contractor knows the software or system the business uses, reducing the need to allocate human resources to bring them up to speed. This knowledge makes the interaction more succinct.

 

Main benefits of hiring an independent contractor

The reasons to hire a contractor are myriad, but the main benefits are:

  • Flexibility: Independent workers give companies flexibility. If they have a deluge of work, independent contractors can help companies finish a project or fulfill orders on a tight deadline. When everything is complete, they can safely terminate the contract or let it come to a natural end.
  • Tax savings: Businesses don’t have to pay Social Security and Medicare taxes, and many states allow independent contractors to pay into a separate worker’s compensation fund because businesses won’t cover that.
  • Less paperwork: While hiring independent contractors requires some paperwork, it’s far less than what’s needed for regular employees. This saves processing time both internally and with the IRS. Also, if the independent contractor is fired, the process is more straightforward and doesn’t have as many problems.

How to properly classify contractors

One of the ways to reap the benefits of hiring an independent contractor is to classify them properly with the IRS. There’s no hard-and-fast rule when it comes to deciding if a worker is an independent contractor or not. The authorities weigh different aspects of the relationship to get a full picture. To properly classify an employee, the company needs to comply with the common-law rules in addition to using the right independent contractor forms.

 

Common-Law Rules

According to the IRS, the act of withholding and paying certain taxes is a key piece of evidence that determines whether you’re hiring an employee or an independent contractor. Additionally, businesses need to weigh three factors, called the Common-Law Rules, that determine the extent of the relationship between your company and the worker. These include:

  • Behavioral control: This questions just how much control the company has over how the worker does their job. Can the employer fully dictate what the employee does, on what days they work or how they will execute the job?
  • Financial control: This rule takes into consideration the financial burden incurred by the business—for example, how/if the worker will be reimbursed and who provides the supplies to do the job. Ultimately, this rule must answer how much control the business has over the economic aspects of the worker’s job.
  • Type of relationship: This rule considers how the worker and business see their relationship. Do they have a written contract or benefits package? What key services are provided, and how permanent is their relationship?

Using the correct independent contractor forms

The first form you need is the W-9, Request for Taxpayer Identification Number and Certification, for individual independent contractors who are U.S. citizens or permanent residents. International ICs need to fill out the W8-BEN. When you get this filled out on the first day, you get their correct tax identification information and address on record immediately.

 

The W-9 becomes the basis for filling out the 1099-NEC, the Nonemployee Compensation form. This form needs to be filled out in January of the tax-filing year if the contract is worth $600 or more. Businesses paying contractors through electronic platforms, such as PayPal, should forego the 1099-NEC and use the 1099-K, Payment Card and Third Party Network Transactions. Copy B of the 1099 form goes to the contractor, while Copy A goes to the IRS by January 31.

 

Businesses that mail their 1099 forms need to add Form 1096: Annual Summary and Transmittal of U.S. Returns, which is a required cover letter for this type of mail transmission. For those that choose to submit electronically, the IRS’s FIRE system requires a transmission code that you can request via Form 4419.

 

Penalties for improper independent contractor classification

The independent contractor forms are simple to fill out, but keep in mind that improper classification can be costly and complicated.

 

Classifying an employee as an independent contractor

It’s important to understand how to hire independent contractors. In the case of misclassification, your company may incur penalties.

 

If the misclassification of an employee as an independent contractor was unintentional, the penalties are straightforward.

  • You will be fined $50 for each W-2 that you didn’t file for the employee you misclassified.
  • Since you didn’t withhold any income taxes, your business will be penalized 1.5% of the employee’s wages and 40% of the Social Security and Medicare (FICA) taxes that you didn’t withhold, and your company will need to match 100% of the FICA taxes it should have paid.
  • There’s also a failure-to-pay penalty for every month you didn’t pay the taxes. The rate is 0.5% for up to 25% of the total amount owed from the tax return due date.

In many cases, this unintentional misclassification can devastate a small business’s finances.

 

Intentional misclassification can be considered fraud. Businesses must pay 20% of all paid wages as well as 100% of each of the employee and employer FICA share. Each misclassified employee incurs a maximum fine of $1,000 and one year in federal prison, and the business owner may be deemed personally liable for the uncollected taxes. States may exact their own penalties as well.

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