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Chances are, your small business already uses independent contractors for some job functions, or could benefit from using them. At least 60% of all businesses use independent contractors, or ICs, and according to the Bureau of Labor Statistics, over 8 million such people are in the workforce. ICs, variously referred to as self-employed, consultants, independent business owners, or entrepreneurs, are people who contract to perform services for a business but don't have the legal status of employees. The ICs, not the employer, control how and where the work is accomplished, and they use their own equipment and supplies.

There is hardly any job that ICs don't perform, from construction to accounting to computer programming to nursing. The reason for this growing trend? Businesses can save time, money, and headaches by hiring ICs instead of employees. Besides paying an employee a salary and other compensation, the business owner must also cover payroll taxes, unemployment, and workers compensation insurance and employee benefits such as health insurance, paid vacations, sick leave, retirement benefits, and life or disability insurance. These expenses add at least 20% to 30% -- often more -- to total payroll costs. Thus, even though ICs are often paid more per hour than employees doing the same work, an employer can still save money by hiring them. In addition, hiring ICs instead of employees reduces exposure to some types of lawsuits, such as those alleging job discrimination or wrongful termination.

Perhaps most important, ICs provides a level of flexibility that can't be obtained with employees. You can hire an IC to handle a specific project, gaining specialized expertise for a short time period without going through the trauma, potential severance costs, and lawsuits that can stem from laying off or firing an employee. Moreover, experienced ICs can save your business the time and expense involved in training employees, and they allow you to expand and contract your workforce as needed, quickly and inexpensively.

Offsetting the advantages of hiring ICs is the risk of an IRS or other government audit. Such audits routinely reclassify ICs as regular employees and assess hefty back taxes and benefits, which can be economically devastating for small-business owners. Fortunately, recent changes in the tax laws and IRS rules should now make it easier for companies to hire independent contractors. The changes include a new IRS audit manual that takes a more reasonable approach to classifying workers and an expansion of the IRS "safe harbor," which lets compananies avoid IRS assessments.

In addition, the risks of hiring ICs can be greatly minimized by taking a few common-sense precautions. Here is a list of 10 things you should do whenever you hire an IC:

1) Use written agreements. A written independent contractor agreement does not automatically mean a worker is an IC, but it certainly helps. Indeed, the IRS audit manual states that in close cases, the existence of a written agreement may tip the balance in favor of a finding that a worker is an IC instead of an employee. A written agreement will help avoid misunderstandings about what services the IC was supposed to perform, payment, deadlines, and other matters.

2) File all required 1099s. You're required to file IRS Form 1099-MISC for any unincorporated IC you pay $600 or more in any year for work done for your business. Failure to file can result in loss of IRS safe harbor protection --the best defense you have against the IRS in a worker classification audit --and also result in increased assessments if the IRS determines that you misclassified the worker. The 1099 must be filed with the IRS by Feb. 28 of the year after the payment was made to the IC. A copy must also be provided to the worker by Jan. 31.

3) Be consistent in the way you use ICs. Try to keep the work your employees and ICs do separate. For example, don't use both employees and ICs as bookkeepers. Using both employees and ICs to perform the exact same services will result in loss of IRS safe harbor protection and make it more difficult for you to win an audit.

4) Obtain ICs' taxpayer ID numbers. Make sure you obtain the taxpayer ID number of any unincorporated IC to whom you pay $600 or more per year. If you don't, you are required to withhold 31% of all payments over $599 made to the IC and remit the money to the IRS. If you fail to pay this backup witholding, the IRS will impose an assessment against you equal to 31% of what you paid the IC. To obtain an IC's taxpayer ID number, ask the person to fill out and sign IRS Form W-9, Request for Taxpayer Information Number, before the job is started, and keep it in your files. You don't have to file the form with the IRS.

5) Let the IC determine where and how to accomplish the job. Remember, ICs are people who are in business for themselves and are not your employees. It's up to the IC to deliver the work as agreed upon in the contract. Your control is limited to accepting or rejecting the final results the IC achieves and doesn't include setting work hours or closely supervising every move.

6) Don't give ICs free equipment and office space. ICs should generally provide their own equipment and office space. However, if you must provide ICs with equipment or office space, charge them for it. Require the IC to sign an equipment or office-space rental agreement.

7) Require invoices for payment. Don't pay ICs on a weekly, bi-monthly, or monthly basis like you do employees. Pay them the same time you pay other outside vendors, such as your office supply company.

8) Hire incorporated ICs. The vast majority of ICs are sole proprietors, running unincorporated, one-person operations. However, some ICs have formed their own corporations. Try to hire incorporated ICs wherever possible, since there is less chance the IRS or other government agencies will view them as your employees. When you hire an incorporated IC, you hire the corporation, not the IC personally.

9) Keep good records. For each IC you hire, establish a file, which should contain the independent contractor's contract, invoices, copies of 1099 forms and any other information that shows the worker is operating an independent business. This may include the independent contractor's business card and stationery, and evidence that the independent contractor has workers' compensation insurance coverage for her employees. Don't keep independent contractor records with your employee personnel files.

10) Understand copyright ownership rules. If you hire an IC to create a written work, artwork, music, photo, video, or other work of authorship, you must have a written agreement transferring copyright ownership to you. Without one, the IC, not you, could end up as copyright owner of the work. It's best to have the IC sign such a transfer agreement ahead of time.

By Stephen Fishman
Fishman is author of Hiring Independent Contractors: The Employer's Legal Guide, (Nolo Press, March, 1997)

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Updated Aug. 21, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.
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