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Hiring and Paying an Independent Contractor

Taxes, Contractor Agreements, Backup Withholding


Many small business owners prefer to work with independent contractors rather than hiring employees, because they think it is somehow "easier" in terms of taxes, benefits, and agreements. But you must still have a contract and there is still paperwork you must complete and taxes that must be allocated.

1. What is an Independent Contractor?

An independent contractor is an individual who does work for an other individual or company. The contractor is, by definition, independent, and not an employee of the hiring company. A perfect example of an independent contractor is a cleaning service. The service comes into your office to do work, but the cleaning service workers are not employees of your company.

2. Make Sure the Worker is an Independent Contractor, Not an Employee

For various reasons (mostly to do with payroll taxes), the IRS is concerned that workers are appropriately classified as either independent contractors or employees. Mis-classification can create tax liabilities, fines and penalties for your business, so be sure that the worker you are hiring is an independent contractor, not an employee. This article explains the difference.

3. New Hire Paperwork for an Independent Contractor

The only new hire paperwork needed for an independent contractor: (1) Form W-9, to provide a taxpayer identification number, (2) a copy of the resume or professional qualifications, and (3) a copy of the contract.

4. Check Credentials Before Hiring an Independent Contractor

In the same manner as you check references for an employee, be sure you check the credentials of a contractor before hire. For example, if you are considering hiring a bookkeeper, make sure this person has no felony convictions. Run through this list of places to check, and don't forget the tried-and-true web search.

5. Paying an Independent Contractor

Paying an independent contractor is pretty simple. You can pay by the hour or by the job, however and the contractor agree. In mst situations, no income tax is withheld, no FICA taxes (Social Security and Medicare) need to be withheld, and no other employment taxes must be paid.

6. Independent Contractors and Employment Taxes

You must keep track of payments you make to independent contractors each year. You do not need to withhold FICA taxes (Social Security and Medicare tax) from these payment. But, for each independent contractor you paid $600 or more during the year, you must report to tttal amount paid  on Form 1099-MISC and give a copy of this form to the contractor for his/her income taxes.

The 1099-MISC must be given to the contractor no later than the last day of January the following year, and a Form 1096 msut be sent to the Social Security Administration by the end of February, with copies of the 1099 forms.

7. Form W-9 for Independent Contractors

William Perez, Guide Tax Planning, wrote recently about changes to the W-9 form that may affect your business, particularly if you are an LLC. Form W-9 must be signed by all independent contractors; it is required in order to provide a tax ID number (social security number, employer ID (EIN), or other.

8. Withholding Income Taxes from an Independent Contractor

In most circumstances, you do not need to withhold income taxes from the payments you make to independent contractors. But there are some exceptions:

You as a business owner and payer must withhold taxes on payments to an independent contractor if:

  • The taxpayer has not given you a taxpayer identification number (Social Security Number, Employer ID Number, or Individual Taxpayer ID Number)
  • The IRS has notified you that the taxpayer ID number is incorrect
  • The IRS has notified you that the taxpayer has not reported all interest or dividend income in prior years

9. Creating a Contract for an Independent Contractor

In every case, before you hire an independent contractor, create an agreement and get it signed by the contractor. The agreement should include details about the requirements of the contractor, pay rates, and sections about non-disclosure and confidentiality. If the contractor is creating intellectual property, the ownership of this property should be made clear. Finally, you may want the contractor to sign a non-compete agreement.

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