What Is an Independent Contractor?

Independent contractors work for themselves they are treated as if they are running their own business. Thus, you are not the employer of an independent contractor, and you aren't liable for payroll taxes or benefits for them, nor are they protected by workers' compensation or most labor laws.

Independent contractors control the performance of the work based on their experience, special license, or special education or training required for the job. In most cases, you tell them the outlines of the project that needs to be done and the due date, and they determine how to accomplish it, on their own schedule. The independent contractor provides the knowledge, experience, and labor to perform the job or provides other individuals to perform the job contracted. Independent contractors are usually paid based on their results (i.e., a flat rate per job, or a per-unit-completed rate) rather than the time they put in.

Independent contractor under the Internal Revenue Code. The IRS frowns on the use of independent contractors, in part because such workers are responsible for paying their own payroll taxes and it's much more difficult to make sure they're doing so.

Generally speaking, for tax purposes the key question is the degree of control you can exercise over the worker. The worker will be treated as an employee if the company has the right to determine not just what the employee does, but when, where, or how he or she does it. The IRS has a 20-factor test that it uses to determine whether an employee is an independent contractor or an employee in disguise. The factors can carry different weights, depending on the factual situation. Generally speaking, if the worker would be considered an employee under at least 10 of the factors, you should treat him or her as an employee.

If in doubt, look at IRS Form SS-8, which is the form used by the IRS to determine individual status for purposes of income and employment taxes.

Independent contractors under the Fair Labor Standards Act (FLSA). The FLSA is another important federal law governing your treatment of workers. Unfortunately, it has its own definition of independent contractor that is slightly different from the IRS's definition. In order to be truly sure that you're safe in treating workers as independent, you must meet both definitions.

Under the FLSA, independent contractors are not "employees" under the federal FLSA and are, therefore, not entitled to minimum wage and overtime protections. There are six factors for determining whether a worker is an "employee" under the FLSA, as opposed to an independent contractor:

  • the degree of the alleged employer's right to control the manner in which the work is performed
  • the alleged employee's opportunity for profit or loss depending upon managerial skill
  • the alleged employee's investment in equipment or materials required for the work
  • whether the service rendered requires special skills
  • the degree of permanence of the working relationship
  • whether the service rendered by the worker is an integral part of the alleged employer's business

No single factor is more important than the others in determining independent contractor status. When the issue comes up in courts, the judge must consider whether, as a matter of economic reality, a worker is dependent on the business to which a service is rendered for continued work. The greater the dependence, the more likely the worker will be found to be an employee.

It's very important to realize that having a worker sign an independent contractor agreement will not automatically create such status if the worker does not meet the requirements of the tests described above.

Workers employed by an independent contractor are not employees of the organization which the contractor is serving they are employees of the contractor.

 
Tip

When working with independent contractors, it is a good idea to develop a written contract relinquishing the right to control and specifying that the worker will not be treated as an employee for federal tax purposes. Employers should also file informational returns (1099 MISCs) for their independent contractors and comply with state laws for workers' compensation and unemployment compensation.

A contract with an independent contractor should also include terms on terminating the relationship. Because independent contractors are not employees, "termination" would be done according to the provisions of the contract. Since a firm and an independent contractor have a contract relationship, not an employment relationship, any misunderstandings about job performance or termination of the relationship are governed by contract law.